Executive Employment Law: Protecting Executives, Entrepreneurs and Employees

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Author: Jotham S. Stein

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executive employment law

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Executive Employment Law P R OT E C T I N G E X E C U T I V E S , E N T R E P R E N E U R S A N D E M P LO Y E E S

Jotham S. Stein

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1 Oxford University Press, Inc., publishes works that further Oxford University’s objective of excellence in research, scholarship, and education. Oxford New York Auckland Cape Town Dar es Salaam Hong Kong Karachi Kuala Lumpur Mexico City Nairobi New Delhi Shanghai Taipei Toronto

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With offices in Argentina Austria Brazil Chile Czech Republic France Greece Guatemala Hungary Italy Japan Poland Portugal Singapore South Korea Switzerland Thailand Turkey Ukraine Vietnam Copyright © 2011 by Oxford University Press, Inc. Published by Oxford University Press, Inc. 198 Madison Avenue, New York, New York 10016 Oxford is a registered trademark of Oxford University Press Oxford University Press is a registered trademark of Oxford University Press, Inc. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of Oxford University Press, Inc. ______________________________________________ Library of Congress Cataloging-in-Publication Data Stein, Jotham S. Executive employment law : protecting executives, entrepreneurs, and employees / Jotham S. Stein. p. cm. Includes bibliographical references and index. ISBN 978-0-19-973785-7 (alk. paper) 1. Executives—Legal status, laws, etc.—United States. 2. Executives—Salaries, etc.—Law and legislation—United States. I. Title. KF1422.S74 2011 344.7301’761658—dc22 2010045098 ______________________________________________ 1 2 3 4 5 6 7 8 9 Printed in the United States of America on acid-free paper Note to Readers This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is based upon sources believed to be accurate and reliable and is intended to be current as of the time it was written. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional services. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Also, to confirm that the information has not been affected or changed by recent developments, traditional legal research techniques should be used, including checking primary sources where appropriate. (Based on the Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations.)

You may order this or any other Oxford University Press publication by visiting the Oxford University Press website at www.oup.com

For Gershon P. Stein And to the memory of Gershon’s Great Zayde, Gershon Grubert, for whom Gershon is named


Contents Acknowledgments xv 1. Introduction 3 2. The Negotiating Playing Field 8 § 2.1 It’s About Leverage 8 Executive Story: Andy 10 § 2.2 Almost Everything Is Possible 11 § 2.3 Business and Legal Issues Mix 11 Executive Story: Pauly 13 § 2.4 The Executive’s Concerns and Need for Protection 13 § 2.5 The Employer’s Motivations 15 § 2.6 The Life Cycle of a Negotiation 16 § 2.7 Economically Irrational Conduct—It Happens All the Time 18 § 2.8 The Impact of the Players’ Personalities 19 3. The Players 20 § 3.1 Executives and Entrepreneurs 20 § 3.2 Founders in Need of Protection 20 § 3.3 The Executive’s Attorney 22 § 3.3.1 The Attorney as Legal Advisor 22 § 3.3.2 The Attorney as Business Advisor 22 § 3.3.3 The Attorney as Lay Psychologist 22 § 3.3.4 Know When to Consult an Expert 23 § 3.4 The Tax and Accounting Expert 24 § 3.5 The Employer 24 § 3.5.1 The Employer’s Constituent Interests 25 § 3.5.1.1 The Board and the Board’s Compensation Committee 26 § 3.5.1.2 Senior Managers 27 § 3.5.1.3 Investors 27

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Contents § 3.5.1.3.1 Public Company Institutional Investors 27 § 3.5.1.3.2 Private Company Investors 28 § 3.5.1.4 Founders as an Employer’s Constituent Interest 29 § 3.5.1.5 Attorneys for the Employer’s Constituent Interests 30 § 3.5.2 The Corporate Employer’s Size, Location, Industry, and Stage of Development 30 § 3.6 Outside Consultants 31 § 3.6.1 The Executive Search Firm 31 § 3.6.2 Compensation Experts 32

4. A Brief Description of the Documents 34 § 4.1 Offer Letter 34 § 4.2 Employment Agreement 35 § 4.3 Commissions and Bonus Plans 35 § 4.4 Equity Agreements 35 § 4.4.1 Founders’ Restricted Stock Purchase Agreement 36 § 4.4.2 Employee Stock Option Agreement 36 § 4.4.3 Employee Restricted Stock Unit Agreement 37 § 4.4.4 Notice of Stock Option Grant or Notice of Restricted Stock Unit Grant 37 § 4.4.5 Employer’s Equity Plan 37 § 4.4.6 Other Employee Equity Arrangements 37 § 4.4.6.1 LLC Unit Option Agreement 37 § 4.4.6.2 Phantom Equity Agreement 38 § 4.4.6.3 Employee Stock Purchase Plan (ESPP) 38 § 4.4.6.4 Employee Stock Ownership Plan (ESOP) 39 § 4.5 Confidential Information and Invention Assignment Agreement 39 § 4.6 Change in Control Agreement 40 § 4.7 Retention Agreement 40 § 4.8 Management Carve-Out Agreement 40 § 4.9 Non-Compete Agreement 40 § 4.10 Arbitration Agreement 41 § 4.11 Indemnification Agreement 41 § 4.12 Employee Benefit Plans 41 § 4.13 Employee Handbook and Company Policies 42 § 4.14 Separation (Severance) Agreement 42 § 4.15 Loans to Executives 42 § 4.16 Performance Improvement Plan 43 § 4.17 Consulting Agreement 43 § 4.18 Corporate Governance Insurance Policies 43 § 4.19 Capital Investment in the Private Company Employer: Financing Documents and Related Agreements 43 § 4.19.1 Preferred Stock 43

Contents § 4.19.2 Stock Purchase Agreement 44 § 4.19.3 Investor Agreement 45 § 4.19.4 Voting Rights Agreement 45 § 4.19.5 Registration Agreement 45 § 4.19.6 Bridge Loan (Bridge Financing) 45 § 4.19.7 Warrants 45 5. The Executive Becomes a Client—The Attorney Begins to Advise 47 § 5.1 The Initial Contact 47 § 5.1.1 The Intake 47 § 5.1.2 The Telephone Interview 48 § 5.1.3 The In-Person Meeting 49 § 5.2 The Fee Agreement and Retainer 49 § 5.3 Understanding the Executive’s Situation 50 § 5.3.1 The Executive’s Chronology of Events 51 § 5.3.2 Review All Relevant Documents 52 § 5.3.3 The Executive’s Due Diligence 53 § 5.4 Educating the Executive 53 § 5.5 Representing Rocket Scientists and Professional Negotiators 54 6. General Negotiation Considerations for Executives 56 § 6.1 The Principals Should Negotiate Directly—Most of the Time 56 § 6.2 Negotiations Should Be Face to Face 58 § 6.3 The Employer May Control the Documents 59 § 6.4 The Executive’s Attorney in the Negotiation 59 § 6.4.1 The Attorney as Shadow Counsel 59 § 6.4.2 The Attorney as Late-Stage Negotiator 60 § 6.4.3 The Attorney as Negotiating Scapegoat 60 § 6.4.4 Be Flexible 61 7. Pre-Employment: Negotiating the Employment Contract and Related Agreements 62 § 7.1 The Executive and His Goals 62 § 7.1.1 What Does the Executive Want? 62 § 7.1.2 The Importance of Protection 62 § 7.1.3 The Employment Agreement as Guaranteed Severance 63 § 7.1.4 The Executive’s Due Diligence on the Prospective Employer 63 § 7.1.5 The Public Company’s Public Documents 63 § 7.2 Avoiding Equity Pitfalls in Private Companies 66 § 7.2.1 What Percentage of the Company Does the Equity Represent? 66 § 7.2.2 What Is the Overhang? Liquidation and Other Preferences 67 Executive Story: Munir 68 § 7.3 Telling the Executive What He Needs to Hear 68

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Contents § 7.3.1 Ensuring the Executive Thinks Through All the Issues 68 Executive Story: Grady 69 § 7.3.2 The Market—Equity Ranges 70 § 7.3.3 The Letter to the Executive Client 71 § 7.4 Anatomy of an Employment Agreement/Offer Letter 71 § 7.4.1 Position and Duties Clause 71 § 7.4.2 At-Will Employment Clause 72 § 7.4.3 Term Employment Clause 73 § 7.4.4 Best Efforts Clause 73 § 7.4.5 Compensation Clause 74 § 7.4.5.1 Base Salary 75 § 7.4.5.2 Bonuses and Commissions 75 § 7.4.5.3 Dodd-Frank’s Clawback Requirements for Bonuses, Commissions, and Other Payments 77 § 7.4.6 Equity Clauses: Key Clauses That May Appear in Employment and Equity Agreements 79 § 7.4.6.1 Types of Equity 80 § 7.4.6.2 Vesting 80 § 7.4.6.3 Maximum Term of the Option 81 § 7.4.6.4 Option Granted at Board’s Discretion 81 § 7.4.6.5 Fair Market Value and Risk Assignment 82 § 7.4.6.6 Changing the Terms of the Stock Option After it Is Granted 83 § 7.4.6.7 Anti-Equity Forfeiture Provisions 83 § 7.4.6.8 Anti-Buy-Back Provisions 84 Executive Story: Jessica 84 § 7.4.6.9 Anti-Dilution Clause 86 § 7.4.6.10 Early Exercise Provision 87 § 7.4.6.11 Right of First Refusal 88 § 7.4.6.12 Incentive Stock Options (ISOs) vs. Non-Qualified Stock Options (NQSOs) 88 § 7.4.7 Employee Benefits 89 § 7.4.8 Reimbursement of Expenses 89 § 7.4.9 Other Employee Benefits or Perquisites 89 § 7.4.10 Reimbursement for Attorneys’ Fees for Review of Employment-Related Documents 90 § 7.4.11 Indemnification and Insurance Clause 90 § 7.4.11.1 Indemnification 90 § 7.4.11.2 Insurance 92 § 7.4.12 CIIAA Clause 93 § 7.4.13 Company Policy and/or Employee Handbook Clause 93 § 7.4.14 Confirmation of Parties’ Entry Into Other Agreements 94 § 7.4.15 No Conflicting Agreements Clause 94 § 7.4.16 Non-Solicitation of Employees Clause 94

Contents § 7.4.17 Non-Compete Clause 95 § 7.4.18 Severance and Acceleration Clauses—Protecting the Executive 95 § 7.4.18.1 The Impact of § 409A on the Employment Agreement’s Severance Clause 95 § 7.4.18.2 Termination Without Cause Clause 100 § 7.4.18.3 Good Reason to Resign (Constructive Termination) Clause 102 § 7.4.18.4 Specified Employee Clause 104 § 7.4.18.5 Single Trigger vs. Double Trigger Protection 105 § 7.4.18.6 Post-Termination Benefits 106 § 7.4.18.6.1 Severance Pay 106 § 7.4.18.6.2 COBRA/Medical Benefits 106 § 7.4.18.6.3 Equity Acceleration 107 § 7.4.18.6.4 Post-Termination Exercise Period Extensions 108 § 7.4.18.6.5 Anti-Blackout Clause 109 § 7.4.18.6.6 Death and Disability 112 § 7.4.19 The Release and Timing of Negotiating the Release 112 § 7.4.19.1 Carve-Outs From the Release 113 § 7.4.19.2 California Civil Code § 1542 115 § 7.4.20 § 409A Clause 115 § 7.4.21 § 280G Clause 115 § 7.4.22 Assignment Clause 117 § 7.4.23 Severability Clause 118 § 7.4.24 Amendment Clause 118 § 7.4.25 No Waiver Clause 119 § 7.4.26 Dispute Resolution Clause 119 § 7.4.27 Governing Law and Venue Clause 120 § 7.4.28 No Mitigation Clause 121 § 7.4.29 Headings Clause 122 § 7.4.30 Notice Clause 122 § 7.4.31 Entire Agreement—Integration Clause 122 § 7.4.32 Counterparts and Signing Clause 123 § 7.5 Stock Option and Other Equity Agreements 123 § 7.6 Employee Confidential Information and Invention Assignment Agreement 123 APPENDIX 126 Example of a Letter to Client Regarding an Employment Offer 126 Sample Employment Agreement 134 Example of a Stock Option Grant Notice 141 8. During (and Sometimes Before) the Employment Relationship 143 § 8.1 Change of Control, Mergers, Acquisitions, and Other Transactions 143 § 8.1.1 Change in Control Agreement 143 § 8.1.2 Management Carve-Out Agreement 147

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§ 8.1.3 Retention Agreements 148 § 8.1.4 Negotiating for the Management Team During Mergers and Acquisitions 148 Executive Story: Zoester, Piper, and Alex 150 § 8.1.4.1 Basic Considerations When Negotiating for Management Teams During M&A Transactions 153 § 8.1.4.2 The Acquirer and the Target’s Management Team 154 § 8.1.4.2.1 Three Practical Realities 154 § 8.1.4.2.2 The Employment Agreement Cram Down 156 § 8.1.4.3 The § 280G Vote 157 § 8.1.4.4 The Non-Binding Dodd-Frank § 951(b) Vote 158 § 8.2 Legal Constraints on Employment Negotiations 159 § 8.2.1 Public Company Public Reporting Obligations 159 § 8.2.2 I.R.C. § 162(m) 160 § 8.2.3 Sarbanes-Oxley Limits 160 § 8.2.4 Securities Laws and SEC Regulations 161 § 8.2.4.1 Securities Law Restrictions 161 § 8.2.4.2 10b5-1 Trading Plans 163 Executive Story: Xerxes 165 § 8.2.4.3 § 16 Short Swing Profits 166 § 8.2.5 Foreign Corrupt Practices Act 166 § 8.2.6 A Short List of Other Federal Laws Applicable in Employment 167 § 8.2.7 Bailout Act and Related Restrictions 168 § 8.2.8 Business Judgment Rule 169 APPENDIX 174 Example of a Change in Control Agreement 174 Excerpts from a Holdback Retention Agreement 182 9. Termination of the Employment Relationship 187 § 9.1 Leaving the Employer 187 § 9.1.1 The Executive Is Fired 187 § 9.1.2 The Squeeze Out—Asking for a Separation Agreement 190 § 9.1.3 The Ultimate Squeeze Out—The Performance Improvement Plan 191 § 9.2 Why Employers Offer Separation Agreements 191 § 9.2.1 Separation Agreements Offered to Secure Releases 192 § 9.2.2 Separation Agreements for Repeat Players 192 § 9.2.3 Separation Agreements Intended to Reflect Corporate Culture 192 § 9.2.4 Separation Agreements Offered Because the Executive Is an Executive 193 § 9.3 ERISA Severance Plans 193 § 9.4 Negotiating the Separation Agreement 194 § 9.4.1 The Executive’s Chronology 194 § 9.4.2 The Loose Market for Severance 194

Contents § 9.4.3 The Departing Executive’s Leverage 195 § 9.4.3.1 Does the Executive Have Legal Claims Against the Employer? 195 § 9.4.3.2 The Difference Between Bad Management and Illegal Conduct 196 § 9.4.3.3 What, if Anything, Will the Executive Do About His Legal Claims? 196 § 9.4.3.4 Perceptions Matter 197 § 9.4.3.5 The Executive’s Preexisting History 197 § 9.4.3.6 The Executive’s Business Leverage 197 Executive Story: Juan 198 § 9.4.4 The Employer’s Leverage 199 § 9.4.4.1 Does the Employer Have Legal Claims Against the Separating Executive? 199 § 9.4.4.2 The Entrepreneur’s Surprise—The Employer’s Right to its Intellectual Property 199 § 9.4.4.3 The Employer’s Business Leverage 200 § 9.4.5 ERISA Severance Plan 201 § 9.4.6 The Letter to the Executive 201 § 9.4.7 The Lawsuit 201 Executive Story: Peritus 202 § 9.5 Anatomy of a Separation Agreement 203 § 9.5.1 Departure Clause: Termination vs. Resignation 203 § 9.5.2 Separation Payments 204 § 9.5.3 Outplacement Clause 205 § 9.5.4 COBRA/Medical Benefits 206 § 9.5.5 Reimbursement of Business Expenses 206 § 9.5.6 Accelerated Vesting/Equity Clause 206 § 9.5.7 Post-Termination Exercise Extension Clause 206 § 9.5.8 Property Retention Clause 207 § 9.5.9 Attorneys’ Fees Reimbursement Clause 207 § 9.5.10 Representation Regarding Payment of Compensation and Benefits 207 § 9.5.11 Continuing Agreements Clause 207 § 9.5.12 Release and Carve-Outs 208 § 9.5.13 Covenant Not to Sue 208 § 9.5.14 Workers Compensation Issues 209 § 9.5.15 Time to Consider the Separation Agreement 209 § 9.5.16 Non-Compete Clause 210 § 9.5.17 Confidentiality Clause 210 § 9.5.18 Non-Disparagement Clause 211 § 9.5.19 Third-Party Reference Clause 212 § 9.5.20 Cooperation Clause 213 § 9.5.21 No Admission of Liability Clause 213

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§ 9.5.22 Forfeiture (Clawback) Clause 213 § 9.5.23 Representation by Counsel Clause 214 § 9.5.24 Other Clauses and Benefits 214 APPENDIX 215 Example of a Letter to Client Regarding a Separation Agreement 215 Example of a Separation Agreement and Release 220 10. The Executive’s Ability to Compete Against His Former Employer—A Brief Overview 226 § 10.1 Non-Compete Agreements 226 § 10.2 Paying for the Non-Compete Agreement 228 § 10.3 Compete and Forfeit Agreements: Employee Choice Doctrine 228 § 10.4 Prohibitions on the Use of a Former Employer’s Trade Secrets and Proprietary Information Even When No Confidentiality Agreement Exists 230 § 10.4.1 Civil Liability and Equitable Relief 231 § 10.4.2 The Inevitable Disclosure Doctrine 232 § 10.4.3 Criminal Liability 232 § 10.5 California: Non-Compete Agreements Are Unenforceable Except in Limited Circumstances 233 § 10.5.1 California State Courts 233 § 10.5.2 The Rise and Fall of the Ninth Circuit’s Narrow Restraint Exception 235 § 10.5.3 The Executive Who Is Subject to an Out-of-State Non-Compete Agreement Moves to California 236 § 10.5.3.1 Jurisdictional Issues 236 § 10.5.3.2 The Race to the Courthouse Steps: California Public Policy vs. the Constitution’s Full Faith and Credit Clause 236 § 10.5.3.2.1 The State Court Race 236 § 10.5.3.2.2 The Federal Court Race 237 § 10.5.3.3 Protecting the Executive in Court Race Situations 238 § 10.5.3.4 The Out-of-State Employer’s Attempt to Impose Non-Compete Agreements on California Employees 239 11. A Brief Word on International Issues Affecting the Employment Relationship 240 § 11.1 Foreign Laws May Apply to the Executive Who Lives and Works in the United States and Never Travels Abroad 240 § 11.2 I.R.C. § 457A May Apply to the Executive Who Lives in the United States and Works for a Foreign Employer 241 § 11.3 Foreign Laws Apply When the Executive Works Abroad 242 APPENDIX: For Executives and Entrepreneurs: How to Find a Lawyer with Experience Representing Clients Like You 244 Table of Authorities Cases 247 Index 263

Acknowledgments

I am grateful to many who helped me while I wrote this book. Thank you to Dan Rosenberg, David Lisi, Jan Katz, and Ken Kuwayti for reading my draft manuscripts and for your numerous insightful suggestions. Thank you to Ben Price, Jake Fisher, and Tamatha Meek for your wonderful research assistance. Thank you to my assistants Valerie Axen and Cindy Goodrich for typing so many revisions into the manuscript, and for doing a great job as intake assistants. Thank you also to my former assistants Christy Jerkovich and Laura Mason. Thank you to OUP editor Michelle Lipinski and OUP production team leader Maria Pucci for all your help and to former OUP acquisition editor Steven Silverstein, without whose inquiry and persistence I never would have written this book. Thank you, of course, to all of my many clients over the years. A special thanks to those who allowed me to use their masked stories in this book. To the many attorneys who have referred me clients over the years, I am deeply grateful. And finally, thank you to my wife Victoria, for all of your love and support. Jotham Palo Alto, California, and Geneva, Illinois

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executive employment law


1 IN T R O D UC T I O N

when an employment relationship is going well, no one wants to think that it may end. Unfortunately, we know that once-perfect relationships sometimes end, and when this happens, someone often suffers. To ensure that your executive and entrepreneur clients are not the ones harmed, you must understand how to protect them before, during, and at the end of their employment relationships. Multiple knowledge, skill, and style sets are required to effectively represent executives and entrepreneurs in their personal negotiations with the companies they love, hope to love, or previously loved. Picayune attention to technical detail is required. Negotiating the definitions of “Cause” and “Good Reason” down to the last sub-clause does matter, especially if things later go wrong. An educator’s touch is required. The entrepreneur may be smarter than you and have invented the next great product. The executive may be shrewder than you and run a 10,000-person company that you could not possibly run. But none of this means the executive or entrepreneur knows much about protecting himself if things go wrong. Some of the worst personal negotiators are vice presidents of worldwide sales who have no problem negotiating tens of millions of dollars in deals for their employers but cannot negotiate basic protective clauses for themselves. Your executive or entrepreneur client may be a quick study and make clear, expeditious decisions. He often needs you, however, to enable him to make these decisions.

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Executive Employment Law

Effectively representing the executive or entrepreneur requires knowing your field. Knowing your field certainly means knowing the applicable laws. And there are many: Employment, securities, contract, intellectual property, and tax law, among other areas of the law, may all be implicated in complex ways during a single representation. But knowing your field means much more. It means knowing the typical documents that comprise a deal, knowing how to apply relevant facts to the law, knowing the market for executive and entrepreneur compensation, and knowing what typically matters and what does not. A knowledgeable practitioner understands that some clauses need to be in those employer-generated contracts, but the power of many procompany provisions can often be negated with the proper language. Knowing your field also means recognizing nonlegal issues and themes that regularly arise—such as when an executive assures you that his first-draft employment agreement will appear by day’s end, when you can be relatively certain that it will not. (And knowing the field as you do, you understand the delay usually has little to do with the level of the employer’s desire to hire and much to do with the slow pace of the employer’s outside counsel or human resources (HR) department.) Dynamism and speed are required. The executive-entrepreneur archetype usually wants everything done yesterday, even when he assures you otherwise. Once serious negotiations begin, your client—and the other side—often demand immediate attention, late-night telephone conferences, long and detailed explanations, and much more. You must be a lay psychologist to be the best at what you do. As the executive’s or entrepreneur’s lawyer, you must do your best to understand your client’s psychology. Sometimes, hand-holding is required. Sometimes tough talk is necessary. Sometimes, simply listening is important. Sometimes, delayed decision making is critical. And sometimes your client’s personality and capacity to hear what you are saying requires a detailed letter with the frank opening paragraph: This is the cover-your-ass letter I said I would write to confirm our prior conversation. As we discussed, you are the client and this is America, and thus, you are free to make whatever decision you want to make. However, in my professional opinion. . . . Recognizing and responding to the psychology of the other side is also imperative. The corporation, the board, and the venture capital funds are all run by humans. And humans are emotional, even when they appear otherwise. They love, hate, and make good decisions as well as bad ones. They can be rational or completely economically irrational. As the executive’s and entrepreneur’s counsel, you must also endeavor to identify the politics driving the other side. The other side may simply be the employer. But this is not always the case. The other side may include investors, attorneys, other executives, and board members, all of whom may be calling the shots and many (or all) of whom may have competing personal, financial, and emotional interests.

Introduction

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The ability to push and recalibrate your client—the ability to tell the executive or entrepreneur things no one else will—is required. Doing a good job may mean bluntly informing your client that he will not receive x, y, and z because no matter how superb his record, the request is more than three standard deviations beyond reasonable. On the other hand, the executive may so desperately want the “premier” job or the entrepreneur may so badly want the investment that without your advice and prodding, he may give up the store. Representing executives and entrepreneurs requires you to have (or learn) negotiation skills. Negotiating for the executive or entrepreneur is, in many respects, similar to any other negotiation. Stripped of everything, you are negotiating for a widget. In this case, the widget is the value of the executive’s or entrepreneur’s labor. Is it possible to represent the executive or entrepreneur purely on instinct? Perhaps top practitioners will do a good job on intuition alone. Diligent practitioners without the intuition gene, however, should easily be able to learn what they need to know to be outstanding representatives for executives and entrepreneurs. And with this knowledge, the conscientious attorney can out-negotiate and out-advise the lawyer relying primarily on intuition. To effectively represent the executive or entrepreneur also requires experience. Experience in dealing with the high-powered, would-be high-powered, and the delusionally high-powered. Experience with applicable laws. Experience with typical documents. Experience with competing dynamics. Experience with many things. That representing the executive or entrepreneur requires experience means this book cannot teach you everything you need to know. Experience is achieved by doing. This book, however, will start you off in the right direction and allow you to identify and learn from important experiences when they occur. The goal of this book is not to present every law, nor every model, nor to describe every document applicable to every possible executive or entrepreneur employment situation. Rather, the goal of this book is to explain the fundamentals of representing executives and entrepreneurs, and by extension, management teams and employees, so that when you are done reading this book, you will realize that you, too, can be a first-class lawyer for these individuals. It goes without saying that not all executives are entrepreneurs, and not all entrepreneurs are executive material. Executives manage companies, and while an entrepreneurial skill set may sometimes be required, this is not necessarily (or generally) the case. For their part, entrepreneurs invent, create, and take risks. They may make great executives but not necessarily. Whether or not an executive is an entrepreneur or an entrepreneur an executive, many of the issues discussed in this book (e.g., protection during the employment relationship) apply equally to both. For this reason, I frequently refer to “executives” and “entrepreneurs” interchangeably in this book. Furthermore, when I refer to the executive or entrepreneur as “he,” I mean “he” or “she.” The organization of this book reflects the phases of an executive’s or entrepreneur’s relationship with an employer. Chapter 1 is this Introduction. Chapter 2 addresses the

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“negotiating playing field” that the executive or entrepreneur faces. It includes a discussion of the life cycle of a negotiation and the relationship between business and legal issues in executive and entrepreneur employment matters. Chapter 3 focuses on the players that the executive or entrepreneur may find on the negotiating playing field. Chapter 4 introduces the myriad documents and contracts that may affect the executive or entrepreneur in his employment relationship. Chapter 5 addresses the executive’s and entrepreneur’s relationship with you, his attorney. Chapter 6 discusses general negotiation considerations for executives and entrepreneurs. It explains when executives and entrepreneurs should negotiate directly with the other side, as well as your role, as the executive’s or entrepreneur’s attorney, in an employment-related negotiation. Chapter 7 focuses on negotiating the executive employment agreement. Chapter 8 discusses both executive-employer contract negotiations that may occur during employment as well as issues that may arise during the employment relationship. Chapter 9 focuses on the termination of the employment relationship, including negotiating the separation agreement. Chapter 10 addresses the ability of the executive or entrepreneur to compete against his former employer. The chapter includes a discussion of non-compete agreements, the unenforceability of most non-compete agreements in California, and what happens when an executive or entrepreneur with a non-compete agreement signed outside of California moves there to compete against his former employer. Chapter 11 concludes with a brief discussion of international issues that may affect both the U.S.-based and foreign-based American executive. “Real-life stories” are included as examples of situations that may occur when you are doing the lawyering. Because personalities and emotions often have huge effects on the ultimate agreement (or dispute), I hope the stories will increase your understanding of what may, and sometimes does, happen. As you practice, you will discover that “genres” of stories—of typical problems, of relevant facts, and of negotiations that follow a relatively predictable pattern—repeat themselves. Some of the real-life stories in this book are examples of “genres” that occur repeatedly, while others are atypical or even unique, intended to trigger the questions: “Do I know everything I need to know? Have I anticipated everything that may occur?” The stories have been modified to mask the identifying details of the executives and entrepreneurs and their particular companies, conversations, and situations. All executives and entrepreneurs, no matter how masked, consented to the use of the stories they inspired. I have deliberately written this book from the perspective of counsel for the executive and entrepreneur (and, by extension, counsel for the management team and employee). There are many books describing how to represent the employer but few, if any, other than this one, devoted to the executive’s and entrepreneur’s side of the aisle. Writing a book from the executive’s and entrepreneur’s attorney’s perspective does not mean I believe the executive or entrepreneur should (or will) receive everything he wants in a negotiation. The fact is that some executives and entrepreneurs are fantastic at what they do, some are mediocre, and some are downright horrid, and any one of these types might ask for more than he should reasonably expect to receive.

Introduction

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A curmudgeon of an excellent attorney once told me after his executive client’s former employer paid millions to settle a hard-fought wrongful termination case: “I would have fired him too.” As the executive’s or entrepreneur’s attorney, your job is to zealously advocate for your client—no matter how good, or bad, an inventor or manager he is. If understanding how to zealously advocate for an executive or entrepreneur is your goal, then this book is for you. This book is also for you if you are company, board, in-house, or investor counsel because it will give you a thorough understanding of what the “other side” may be thinking. This, in turn, has at least two distinct benefits. First, the ability to anticipate the executive’s potential concerns, and likely courses of action, before or during a negotiation will make you more informed and effective. Second, to the extent you find yourself advising executives and entrepreneurs, this book may help you “fill in the blanks.” As it turns out, many (although surely not all) corporate attorneys do not do the best job representing their entrepreneur and executive clients even when they are laboring hard to do so. The reason may be that these attorneys spend most of their professional lives inculcating the employer’s perspective, understanding everything about their corporate or investor or board clients but not understanding, at the same level, their executive or entrepreneur clients’ concerns. When it comes time to advise them about the best contract possible, these corporate attorneys come up short. Consequently, the perspective of this book will benefit company, in-house, investor, and board counsel as much as the entrepreneur or executive and his attorney. This book is also for you if you are an entrepreneur or executive, or a would-be entrepreneur or executive. Although I have written this book from the perspective of the attorney representing executives and entrepreneurs, this book is as much about you the executive and you the entrepreneur as it is about the attorneys representing you. Change the phrase, “your executive client” to “you,” or to “you the executive,” or to “you the entrepreneur,” and this book becomes a “how to” book written for you the entrepreneur and you the executive. But retain an experienced lawyer. You will almost certainly need one.

2 T H E N E G OT I AT I NG PL AYIN G F IE L D

§ 2.1 It’s About Leverage

Negotiating an agreement for an executive or entrepreneur is all about leverage. Leverage, in turn, is bound up in perception—how much someone believes he needs somebody goes a long way toward defining the negotiating leverage of that someone and somebody. In the executive hiring context, relevant questions to consider when assessing leverage include: • How badly does the prospective employer (or its board or its investors) want the executive, and for what reasons? • What are the employer’s constraints in offering employment to the executive? For example, is the employer limited by shareholder concerns, investor concerns, or concerns about setting precedents; and what, if anything, will overcome these concerns? • What are the employer’s concerns, if any, about the executive’s potential to perform? • What does the executive’s resume and experience say about the executive and his attractiveness to the prospective employer? • Does the executive want to work for the prospective employer; and if so, how badly and why? • What, if anything, is the executive leaving on the table if he joins the would-be employer? 8

The Negotiating Playing Field

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• What are the executive’s concerns in the employment negotiation? • How hard is the executive willing to negotiate in the employment negotiation? The more a prospective employer wants the executive to run its company and the more the executive is willing to negotiate hard to optimize his personal return, the more likely the executive is to negotiate a better employment package. Similarly, the more the entrepreneur’s high-tech product is the next sure financial blockbuster, the more likely the entrepreneur will be able to negotiate protective terms in the next round of venture capital financing. On the other hand, the more an entrepreneur is desperate for that next tranche of financing, the more likely he is to lose control of his company. Negotiating for the executive or entrepreneur is similar to negotiating any other deal, except here the widget being negotiated is the executive’s or entrepreneur’s labor. It is really this simple. Would-be CEOs often ask: What is the market (for my salary, stock options, and so forth)? What do you think I can get in the negotiations? What do you think they (the company, board, investors) will give me? The answer: It is all about leverage, bounded by actual constraints. On average, the CEO who has previously brought two companies public is much more likely than the first-time CEO to negotiate a better employment agreement with a company planning to go public. Similarly, the expert in a select high-tech, biotech, or new-tech field is likely to command a higher salary and more options than the leader who has no experience in those same fields. Because the negotiation over the executive employment agreement usually begins after the prospective employer has completed its interview and selection process, the executive begins the negotiation with built-in leverage. On the one hand, the prospective employer may have spent significant resources—in time, money, and, perhaps, opportunity cost—before choosing the executive as “the one” (or the leading candidate). From the perspective of the employer’s decision makers, the chosen executive is the “right” hire, and because he is the “right” hire, he presents the best opportunity for company growth. There will be a natural desire to “close” the deal by hiring the executive, which, in turn, provides the executive with leverage. Furthermore, the cost of a failed executive hire can be so significant that once the decision makers choose the executive as the “first choice,” they may be disinclined to move to their second one. From the perspective of the employer’s decision makers, choosing a lesser alternative increases the likelihood of a suboptimal or failed hire. This dynamic provides the executive with leverage. Leverage also plays a role in the back-end severance negotiation, although given the at-will nature of most employment relationships, that leverage plays a role is not as obvious. Most executives or entrepreneurs who negotiate severance agreements without having protective employment agreements in place start out behind because employers usually have no legal obligation to provide any severance to their departing or former employees. Why employers give severance when they are not legally required

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to do so and the details of negotiating a severance package are discussed in chapter 9. Suffice it to say at this point that those with leverage start out ahead, even if they have just been fired. For example, chief financial officers usually, although not always, are given attractive severance agreements, even when they have been fired for incompetence. Could this be because they know where everything is hidden? Knowledge is leverage, even if its potential use remains unstated. Real constraints do exist (as opposed to the “we-can’t-possibly-do-this” constraints thrown about during negotiations). For example, with SEC disclosure requirements, changes in federal statutes and regulations, and the prevalence of consulting firms retained to advise publicly traded companies’ compensation committees about the compensation “ranges” for executives, the power of many executives to demand extraordinary compensation packages has been counterbalanced somewhat by the compensation committee’s fear of being outside (on the upside) of a “market” compensation range. But even with a compensation committee religiously devoted to a compensation range, the highly sought-after CEO will probably be able to negotiate for more than the run-of-the-mill CEO. There is always the eightieth, ninetieth, ninety-fifth, and ninety-ninth percentile of a compensation range. Executive Story Andy was the chief marketing officer for a publicly traded company. He had worked his way up in the company during his career. But Andy lost a corporate battle with another executive who had literally hated him for all those years. The other executive fired Andy just because he was Andy. Andy knew the marketing of his ex-employer’s products inside and out. He was also intimately familiar with the competitors’ products. The ex-employer feared Andy would reappear at a major competitor, which was a real possibility given Andy’s experience and high profile, and the fact that Andy had never signed a non-compete agreement. If Andy created and executed a marketing plan for a competitor that juxtaposed the strength of the competitors’ products against the weaknesses of Andy’s ex-employer’s products, the potential costs to the ex-employer could be significant. Andy had leverage: leverage to demand a severance package in return for not working for a competitor. However, the ex-employer did not simply roll over and give Andy whatever he requested. Because Andy had no employment agreement guaranteeing him severance and accelerated vesting, and because his ex-boss was emotionally involved in Andy’s demise, a lengthy negotiation ensued with various executives at the ex-employer saying and doing all sorts of things. In the end, the ex-employer agreed to a multimillion dollar severance package, including monthly salary continuation payments and accelerated vesting, to keep Andy on the beach and off the job market for a number of years.


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§ 2.2 Almost Everything Is Possible

The employment relationship is a contractual relationship. Employment agreements, severance agreements, and stock option agreements are contracts. Unless a clause is illegal or void against public policy or unless there is an overriding deal breaker constraint on the other side, any clause can be written into a contract if the entrepreneur or executive has sufficient leverage. This includes clauses that no one has yet invented. Consequently, while this and later chapters describe the executive employment playing field and discuss a wide variety of employment-related situations, clauses, and documents, by no means do they cover every possible situation, clause, or document. If you practice long enough, you will see some very idiosyncratic terms included in employment-related agreements. When an executive client asks you, “do you think you can write [ _____ ] into the agreement?” consider responding with: “I can write whatever terms you negotiate into your employment agreement, as long as they are not illegal and do not violate public policy.”

§ 2.3 Business and Legal Issues Mix

To provide the best advice to your executive clients, you must be prepared to offer both business and legal advice. After you have learned everything you need to know about your executive client and his prospective deal, you should be able to turn to your client and begin a conversation with something similar to: The law says [ ________ ]. Given your business goals, the language you should add to your employment agreement to best protect your interests is: [ __________ ]. This is the language the other side proposes: [ _________ ]. If you agree to the other side’s language, then you will take the risks of [ ________ ]. Given your business goals and risk tolerance, I recommend [ ________ ]. If you are a lawyer who loves the law, loves to give legal advice, but dislikes giving business advice, then consider advising other types of clients. Similarly, if you are all about business advice and do not feel comfortable with legal issues, you have only to look at Internal Revenue Code (I.R.C.) § 409A and its 397 pages of implementing regulations1 to know you should consider a different area of the law.

1

26 U.S.C. § 409A. The 397 pages of § 409A regulations, entitled “Application of Section 409A to Nonqualified Deferred Compensation Plans,” are available at www.treasury.gov/press-center/press-releases/Documents/ td9321.pdf. The citation “26 U.S.C. § _ _ _” is identical to the citation “I.R.C. § _ _ _.” In this book, the two citations are used interchangeably.

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No matter how shrewd your client, no matter how wealthy your client, no matter how much of a king or queen in their particular kingdom your client is, your executive or entrepreneur client will probably require business advice from you. Some of the best negotiators in the world—the kind who have no problem negotiating multimillion dollar deals for their employers—cannot negotiate for themselves. They will depend on you for business advice. If you practice long enough, the following is a genre of a conversation that you will undoubtedly have on multiple occasions: You: “So, you were in charge at the company, made the lion’s share of your income in bonuses and commissions, did multiple multimillion dollar deals this year, and you are telling me your bonus and commission plans were not in place, you were more than half way into the year, and you just got fired?” Executive: “Well, things were uncomfortable with the CEO since the beginning of the year so we never got around to finishing up the bonus and commission plans. . . .” It is true that some executives and entrepreneurs are great negotiators who have the ability to secure good deals for themselves, arrangements that may be significantly better than most executives or entrepreneurs can negotiate. But even with these great personal negotiators, more often than not, your sage counsel will help their good deal become better. How hard to push in a negotiation is a business issue. As the lawyer, you probably will not make the decision on how hard to push. But, to do the best job, you should be able to lay out the decision tree for your executive client. You should understand your clients’ career trajectories, the businesses with which they are involved, the marketplace for their services, and the other business considerations discussed in this book. Knowing the business side of a transaction is not enough, however. Being able to give excellent advice to an executive requires that you be thoroughly familiar with the law applicable to the executive’s transaction. In the executive negotiation world, the law can be a picayune pain and sometimes have little relation to the logical. I.R.C. § 409A, § 280G, § 4999, and the SEC’s insider trading and tipping rules, to name just a few of the laws potentially applicable to executives, are complex and not always clear.2 Negotiations over the meaning of “Cause” in an employment agreement provide an example of the interplay between business and legal issues. Many executive employment agreements contain severance and equity acceleration provisions for the executive that are triggered in the event the employer terminates the executive without Cause. When negotiating the employment agreement, the executive almost always pushes for a narrow definition of “Cause” to reduce the risk that the employer will have a reason

2

26 U.S.C. §§ 409A, 280G, 4999. The insider trading and anti-tipping provisions arise from the Securities Exchange Act of 1934, 15 U.S.C. §§ 78t-1, et seq. Both the Treasury Department and the SEC have promulgated extensive implementing regulations for the applicable statutes.


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(or invent a reason) to terminate his employment for Cause. By contrast, the employer almost always pushes for a broad definition of “Cause” to ensure that it will have maximum flexibility when terminating the executive’s employment.3 Negotiations involving the meaning of Cause in an employment agreement can take ten minutes . . . or days, depending on the life cycle of the negotiations. While Cause will have a specific legal meaning in the employment contract, the way the term is fleshed out in a given employment negotiation depends in large part on business considerations. As the words used to define Cause change, the risk to the executive of a for Cause termination under the employment agreement shift. Executive Story Pauly, the prospective CEO of a struggling publicly traded high-tech company, negotiated an employment contract for months with the company’s chairman of the board, a seasoned industry veteran. Pauly finally had enough and told the chairman that he would not negotiate any further unless everyone showed up in a room to either get the deal done or let it fail. The following week, the parties and their attorneys met at company headquarters. At some point, the negotiation arrived at the definition of “Cause” in the employment agreement. After reviewing Pauly’s proposed definition of Cause, the chairman turned to me, and said, “But if he doesn’t perform, I need to be able to replace him.” To which I responded, “The company is taking the risk that Pauly is incompetent. If you think he is incompetent, don’t hire him. If he turns out to be incompetent, you’ll pay him severance. Incompetence is not Cause.” “OK, I see,” the chairman said. The deal got done that day.

§ 2.4 The Executive’s Concerns and Need for Protection

Executives are fired all the time. Boards change. Management teams change. Companies merge. Companies sell divisions. New management teams arrive, and, rightly or wrongly, they sometimes do not see the need to retain the “old” executives. Sometimes those who negotiated the employment on behalf of the employer are not around in later years. Sometimes the firing is deserved, and sometimes it is not. Employment contracts are often nothing more than severance agreements signed on day one of the employment relationship. This is especially true in at-will employment relationships where the employer may fire the employee, including the CEO, at

3

For a further discussion of the definition of Cause in employment agreements, see § 7.4.18.2.

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any time, for any reason, or no reason at all (except an illegal one, such as a firing resulting from unlawful discrimination). The executive should negotiate his employment and severance contract before he starts employment because his leverage will usually be greater than after he is terminated.4 An employer that wants the services of an executive is more likely to offer the executive a good severance package on the front end, especially where it is commercially reasonable to do so. Executives—no matter how accomplished—who wait to negotiate severance on the back end (after their employment terminates) typically receive worse deals than they would have received had they negotiated for severance and accelerated vesting in their employment contracts. This learning can be especially painful for executives when they lose millions of dollars because they failed to protect themselves at the start of the employment relationship. Are there “exceptions”? Of course. Sometimes executives negotiate amazing back-end deals.5 For the most part, however, the quality of an executive’s severance package will be better if negotiated at the outset of employment. Furthermore, negotiating an employment agreement at the beginning of employment does not preclude the executive from negotiating additional benefits at the conclusion of the relationship. At the most basic level, executives and entrepreneurs negotiate for severance packages to protect their family and their earning potential, equity, and cash flow if employment is unexpectedly severed. In addition, the executive and entrepreneur as capitalists frequently want to squeeze everything possible out of a severance negotiation, leaving nothing on the proverbial table. The executive’s or entrepreneur’s goal on the front end is often to maximize protection in the event of a termination of employment without Cause or in the event that the executive or entrepreneur is “constructively terminated” (meaning he has

4

In certain situations, some senior-most executives (usually CEOs or CFOs) may feel their negotiating position is not hampered if they begin employment before finalizing their employment agreement. In these circumstances, the executive calculates that his leverage increases (or is at least the same as if he did not start work) because the employer will be worse off if he quits in the first week or two after the employer has announced that the executive will be leading the company. The executive should use this negotiating strategy with caution. In most circumstances, the executive will be better off negotiating his employment agreement before beginning employment. 5 Are the “exceptions” the norm among a certain category or subcategory of executives? Perhaps. In a study of 179 CEOs of Fortune 500 companies who left their employers between 1996 and 2002, David Yermack of New York University’s Stern School of Business found that CEOs who were fired without employment agreements received more separation pay than CEOs with employment agreements. However, Professor Yermack did not (and probably could not) determine how much more (or less) separation benefits the group of CEOs without employment agreements would have received had they negotiated employment agreements at the outset of their employment relationships. Yermack’s study also found that 12.5 percent of the CEOs without employment agreements received no discretionary separation pay. David Yermack, Golden Handshakes: Separation Pay for Retired and Dismissed CEOs, 41 J. Acct. & Econ. 237, 246 (2006).


15

“Good Reason” to resign).6 Protection often means, on termination of employment, the executive receives: • Payment of cash; • Payment for or reimbursement of premiums for Consolidated Omnibus Budget Reconciliation Act (COBRA) benefits7; • Accelerated vesting of equity (stock options, restricted stock units, etc.); • An extended post-termination exercise period for vested stock options; and • Payment of other benefits or provisions of other perquisites (e.g., car allowance).

§ 2.5 The Employer’s Motivations

Employers, particularly mature companies, frequently have established policies or historically or culturally established ways of doing things in employment matters. Generally, employers desire maximum flexibility and minimal strings in their employment relationships. The employer usually desires to retain its right to terminate all employees at any time, with or without notice, for any reason or no reason at all (except an illegal reason). This is generally the case even where the employer has a munificent ERISA8 severance plan that provides excellent benefits to employees whose employment is terminated without Cause. Employers often seek broader definitions of Cause, narrower definitions of Good Reason, and double trigger severance clauses.9 Shrewd employers understand the marketplace and are frequently willing to pay for executives who they believe will lead their shareholders to the promised land. These companies are willing to provide healthy compensation and severance packages because employment and severance agreements are often a small cost of doing business when companies succeed (if the executive causes the positive performance). Nevertheless, even while providing generous terms to executives, these employers will usually do their best to maintain as much flexibility with as few strings in the employment relationship as they can negotiate. During employment, the employer’s goal is almost always to ensure the executive is incentivized to work long and hard to maximize corporate profits. The employer wants executives who put positive performance first and foremost, sometimes to the detriment of everything else. In acquisitions, the acquirer will usually seek to incentivize

6

“Good Reason” or “Constructive Termination” clauses in executive employment agreements typically allow the executive to resign employment and collect separation benefits in the event that various material negative events occur during employment. These clauses are discussed at § 7.4.18.3. 7 Consolidated Omnibus Budget Reconciliation Act of 1985, Pub. L. 99–272, 100 Stat. 82. Title X, codified at 29 U.S.C. § 1161, et seq. 8 Employee Retirement Income Security Act of 1974, 29 U.S.C. § 1001, et seq. 9 Cause, Good Reason, and double trigger severance clauses are discussed at §§ 7.4.18.2, 7.4.18.3, and 7.4.18.5.

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the management team to remain, at a minimum, for as long as it takes the acquirer to successfully integrate the target. Except in situations where the employer’s board is in serious conflict, the goal of most boards is to have the CEO and management team succeed wildly. Executive team success will increase company and share value. By contrast, the cost of a failed executive hire may be very high.10

§ 2.6 The Life Cycle of a Negotiation

All negotiations have life cycles, including employment-related ones. Doing your best to understand where, as a business matter, your executive client is within the life cycle of his negotiation, and advising him accordingly, will make you a valuable asset in the negotiation. The difficulty with understanding where your client is in the negotiation life cycle arises from the unique fact pattern present in every negotiation. The difficulty is compounded because assessing the stage of the negotiation life cycle requires being in the negotiation, and the assessment will change as the negotiation progresses. While more art than science, understanding the stage of the negotiation life cycle is critical. If the executive throws in the towel too early, whether conceding critical terms or, on the other hand, withdrawing from the negotiation, he may be doing himself a disservice. By contrast, if the executive pushes too hard for too long or does not recognize the deal breakers staring him in the face, he may tank the deal. Recognizing the stage of the negotiation life cycle informs you about the positions that the executive may take without risking a premature demise of the negotiation. The recognition also helps you understand how long it might take to conclude the negotiation. Concluding the negotiation may take significant time because negotiation life cycles often cannot be pushed, no matter how badly your client wants to do the deal. For example, early in a negotiation, the employer may take a position that is a deal breaker for the executive. At this early stage, however, there is rarely a reason to put the proverbial “line in the sand,” no matter how upset the executive is. Early in a negotiation, it is sometimes necessary to firmly and laboriously explain to the employer that the executive will never agree to the deal-breaker term. And it may take the other side some huffing and puffing to concede the elimination of the deal-breaker term, even though at the outset you, the experienced negotiator, believed with 95 percent certainty that the deal-breaker term eventually would be dropped.

10

Estimates of the cost of failed executive hires vary widely and may not be reliable. The actual cost to an employer of a failed executive hire undoubtedly depends on each employer’s specific circumstances. The Web site of the payroll outsourcing service ADP contains an interesting “Bad Hire Calculator” at www. adpselect-info.com/badHireCalculator.html.


17

Executives and entrepreneurs, most often engineers and other black-and-white types (either the product works, or it doesn’t work), are sometimes aghast when the other side says, “no way, no how, never under any circumstance.” These horrified clients tend to assert early (and sometimes often) that they are ready to walk out the door because the other side is being unreasonable and intransigent. This is when it may be time to tell your client that “no way, no how, never under any circumstance” at an early stage of the negotiation does not mean that the other side will say “no way, no how, never under any circumstance” later in the negotiation. It may be the other side’s intransigent position but not necessarily. The executive will only know as the negotiation develops. In front-end negotiations over the terms of an employment relationship, the parties go to bed with each other (metaphorically anyway) as soon as the deal is done. The executive’s goal should be to push hard, but within the negotiation life cycle, so that at the end of the day the employer (board, acquirer, investors, etc.) respects the employee for the personal deal he has struck and looks forward to the days when the executive will be negotiating on behalf of the company.11 Recognizing the executive’s place in the negotiation life cycle is not always straightforward and comes easier to some than to others. As a basic matter, the negotiation life cycle has a beginning, a middle, and an end. As a rudimentary matter, the beginning of the negotiation life cycle includes the parties’ initial positioning and signaling, usually an offer, and perhaps a counteroffer. The middle phase of the negotiation involves additional positioning and signaling, possibly bouts of intransigence or horse trading, and perhaps multiple iterations of offer and counteroffer. The end of the negotiation life cycle may include a convergence of positions into an agreement, or alternatively, an impasse or the breakdown of the negotiation. Somewhere within this basic rubric, add the possibility of multiple trial balloons, and, perhaps, threats to walk out the door. There is no surefire road map to the life cycle because executive negotiations happen in so many different ways and with so many different types of people. Game theorists might analyze with statistics and game theory; however, these theories are informative but, to invoke a legal phrase, not dispositive. Negotiations involve people. People do not always act as others expect, nor do they always act rationally. Negotiations, which are nothing more than a series of multiparty interpersonal interactions, must be assessed on a case-by-case basis. Learning to identify the life cycle of a negotiation is best accomplished by participating in negotiations. Books on game theory and negotiation strategies can be excellent preparatory tools. But at the end of the day, it will be your call as to where your executive client finds himself in any particular negotiation. Being aware that the executive’s negotiation has a life cycle is half the battle. As the executive negotiates (or you negotiate on his behalf), do your best to gain a feel for

11

You will know this has happened when players at the employer begin referring their friends and colleagues to you.

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the life cycle of the negotiation. Stop yourself periodically and ask: In what part of the life cycle of the negotiation is my client? The executive caught in negotiating his own deal may not have the presence or patience to look at the big life-cycle picture. You are there to help.

§ 2.7 Economically Irrational Conduct—It Happens All the Time

The theory that people always act in their economic best interest—that is, as a “rational man” would act—provides the foundation for much of economic theory. If you represent executives and entrepreneurs long enough, you may want to return to your alma mater as a guest lecturer in a basic economics course and begin the lecture with: “I’m here to tell you that man acts irrationally all the time. Question your professor when he tells you otherwise.” Rational man models probably work on a macroeconomic level. They may even work on an aggregate microeconomic level. But they cannot be used to predict behavior in any particular employment (microeconomic) situation. In other words, employers (which are nothing more than sets of human decision makers) regularly act economically irrationally. The cause for the economic irrationality may be ego, personality disorders, jealousy, pet peeves, biases, or myriad other reasons. Senior executives fire subordinates all the time because they feel threatened by them. The conduct is economically irrational from the perspective of the employer (and thus is akin to corporate deviance) but economically rational from the individual senior executive’s perspective. Senior executives who fire more successful subordinates may extend their expected length of service for their employer. The result: Firings in significant numbers occur in numerous companies in situations where the shareholders would vote against the firing, if allowed to vote on the matter. It is sometimes very difficult for the successful executive to appreciate the risk that he too may be fired in an economically irrational employment termination. Many have the attitude (often not expressed) that these types of employment terminations only happen to other people. Thus, even though your executive client may listen to your warnings, he may not “hear” them. As the attorney for the entrepreneur or executive, you should: • Advise your client about the possibility that his employer or prospective employer may terminate his employment for economically irrational reasons; • Do your best to ensure that your client absorbs your warning that his employer may act economically irrationally toward him; • Advise your client about the best ways to protect himself and the risks of not doing so if his employer terminates his employment economically irrationally.


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§ 2.8 The Impact of the Players’ Personalities

Stripped of everything else, a negotiation is a series of communications between people who are attempting to achieve a result of one type or another. Because negotiations are people-driven, the players’ personalities may be critical components of the negotiation. The more that you and your executive client understand the personalities involved, the more likely you are to give better business advice, and the more likely the executive will achieve his goals. For each key player on the other side of a prospective negotiation, questions to consider before the negotiations begin include: • • • •

Who is the person on the other side of the negotiation? What drives him or her professionally, personally? What is he or she like? What type of a negotiator, and what style of negotiation, is he or she most likely to respect? • Given the personalities involved, what will maximize the executive’s chances of achieving his goals in the negotiation? Your client’s personality will also play an important part in the negotiation and perhaps the way in which he receives (or hears) your advice. Consequently, the more you understand about your client’s personality, the easier it will be for you to help the executive most effectively negotiate, and the easier it will be for you to ensure that he hears your advice.

3 T H E P L AY ERS

§ 3.1 Executives and Entrepreneurs

Executives and entrepreneurs come in all sorts of mental states and perspectives and all varieties of personal and interpersonal abilities. Some are mature, as honest as the day is long, and self-confident, and they know how to manage companies. Others are immature; dishonest; insecure; and, at best, mediocre managers. Many executives or entrepreneurs will automatically respect you, but others will behave only because an authority figure has told them you know what you are talking about, and you will fire them (as clients) if they are too difficult. Be prepared. And do not be fooled. Because an executive or entrepreneur earns (or will earn) huge sums of money, or has brought multiple companies public, or is a god in his particular field, does not mean the executive or entrepreneur is a good person, nor does it mean he is competent in any area other than his field of expertise, nor does it mean he has any idea how to negotiate his employment agreement.

§ 3.2 Founders in Need of Protection

Founders start companies. They are the entrepreneurs with business dreams and the will to sacrifice to advance those dreams. Founders are the men and women who will do without paycheck after paycheck, forgoing personal and financial advancement at 20

The Players

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a secure job for the chance of creating a business in their image and realizing the potential of a huge financial upside. They are on the front lines of innovative and entrepreneurial America, repeatedly pushing the envelope, in a very real sense, for all of us. Sometimes founders are desperately in need of protection in the same way that executives and nonfounder entrepreneurs need protection in their employment relationships. On the other hand, sometimes founders are key players (or the most significant players) at the employer with whom the executive is negotiating. The experience of founders at the companies they create runs the gamut, as does their view on the importance of securing a strong employment agreement. The stories are legendary of founders selling their companies for millions, retiring early in life, with more wealth than most people would see in multiple lifetimes. Some had very protective employment agreements. Others, none at all. So too, however, are the stories of founders being stabbed in the back, fired from the companies they built, and forced to watch from the sidelines as their equity is diluted, and wrongdoers bring their dream public, reaping disproportionate awards at the founders’ expense. Most of these founders had no employment or equity protection whatsoever. First-time founders sometimes suffer unprotected demises from the companies they formed because they mistakenly relied on corporate counsel to look out for their best interests when they founded their companies or during other key corporate events, such as venture capital financings. Some of these founders were never advised to consider retaining independent counsel and did not realize that they might need to do so. Others were too trusting, too poor, too cheap, or too afraid to “upset” their new lawyer and investor “friends” to retain independent counsel. In the start-up world, some corporate lawyers’ “loyalties” lie with the start-up world’s repeat players (e.g., venture capitalists, repeat angel investors), not with the founders who bring them companies to found and advise. In part, this is because the corporate lawyer represents the company, not the founder. As the corporation’s lawyer, the attorney’s job is to suggest legal structures and documents that protect the company, not the founder. Sometimes, however, less noble concerns are present. Take, for example, a first-time founder who retains a corporate lawyer to represent his company during its initial venture capital financing. The venture capitalist investing in the company may do ten or twenty deals a year in which the corporate lawyer or his law firm are involved. Furthermore, the venture capitalist may sit on multiple boards of companies that pay the corporate lawyer or his law firm to work for them. Even if the venture capitalist never retains the corporate lawyer, the attorney might be very sensitive to the needs of (and make sure not to upset) the venture capitalist. In turn, this may influence the corporate lawyer’s decisions on the type of clauses to include (or to advise be included) in the investment documents. It may also affect his decision not to stress, or simply not to suggest, that the founder retain independent counsel.

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The saddest stories are those where the wrongdoer is the person who stood up at the founder’s wedding. It has happened multiple times. Money sometimes brings out the worst in people. Scenarios in which the founder is a victim of backstabbing are invariably enabled after the founder reaches a crucial point in his professional life: the point when the founder loses corporate control of his baby. At that point, for better or worse, the founder no longer controls his professional destiny. His protection—if he chooses to protect himself—is the employment agreement and related equity protection clauses.

§ 3.3 The Executive’s Attorney

§ .. the attorney as legal advisor It should not come as a great surprise that the executive has retained you because of your skills. Make sure you know everything you can about the laws that affect your executive client’s employment. This means knowing the relevant laws of your state and applicable federal law. In multijurisdictional situations, you must either know the relevant law in all relevant jurisdictions or associate with a lawyer who does. As explained in § 3.3.4, know your limitations. If you need a specialist to assist, ensure your executive client retains one. § .. the attorney as business advisor As an attorney representing executives, you will become a business advisor. Most executives value counsel who is able to give them business advice. It starts with the question: “Do you think my offer is at market?” And it goes on from there. There are many ways to educate oneself about the business of representing executives. Ask questions of those around you. Read. Attend conferences. Listen to your executive clients (remember that genres of situations repeat themselves). Spend time speaking with lawyers who principally represent companies. How else can you know what employers, as a general matter, want? Do not hesitate to call corporate attorneys or take them out to lunch and ask them direct questions about the business environment. Most lawyers will be happy to share their experiences with you.

§ .. the attorney as lay psychologist Like it or not, if you represent executives, you will become a part-time lay psychologist. That an executive never earned below an A+ in his life and is a star in the business world does not mean he is even-keeled or that he faces difficult situations with reserved aplomb.

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Few if any executives, no matter how successful, no matter how wealthy, no matter how secure, and no matter how superior their severance package, enjoy being fired, or, on the day of their firing, are able to operate coldly and calculatingly. When an executive calls on the day of his termination, listen, but (except in very unusual circumstances) suggest that he call back in a day or two for advice and make no significant decisions until he does so. This will give him time to cool down and become the cold and calculating negotiator that best serves his interests. Invariably, you will hear myriad non-legal concerns from your executive clients, and you must be ready to address them. Your clients will worry about their families, about their cash flow, about their reputations, about being blackballed, and so much more. As their attorney, you must listen, understand, and be able to offer astute advice. At first, offering sage advice is not easy because, naturally, you need experience to be able to offer excellent advice. By reading this book, speaking with others, and educating yourself, you should be able to give excellent advice sooner than you realize. § .. know when to consult an expert Know your limitations. The world of advising executives and entrepreneurs touches on many complex legal and accounting issues. You may face issues with which you have little experience and realize you need the help of an expert in a particular field. For example, if you represent the management team of a private target during merger negotiations, unless you are absolutely sure you know what you are doing, do not undertake the complex § 280G calculations necessary to determine whether the parachute payment excise tax under § 4999 is triggered by the acceleration of your executive client’s post-change in control options.1 To do the best job for your executive client, you must understand parachute payment law so that you are able to spot 280G issues early on in a transaction, but you probably should let the 280G expert determine whether the transaction will cause parachute payments.2 If you feel you need assistance, then obtain the help you need immediately. Compensation consultants may be desired if the executive is negotiating with a public company. Securities law experts may be needed if your executive client has a difficult securities-related issue. Foreign counsel may be necessary if a foreign nation’s laws are implicated. As a practical matter, the executive will almost always understand and pay for the additional assistance.

1

26 U.S.C. §§ 280G, 4999; Treas. Reg. § 1.280G-1. The calculation to obtain the parachute payment value of shares subject to a stock option whose vesting accelerates on a change in control is complex. See Treas. Reg. § 1.280G-1 Q&A 24(c). The citation “Treas. Reg. § _ _ _” is identical to the citation “26 C.F.R. § _ _ _.” In this book, the Treas. Reg. § _ _ _ cite is used rather than the corresponding 26 C.F.R. § _ _ _ cite. 2 § 280G issues are discussed at greater length in § 7.4.21 and § 8.1.4.3.

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§ 3.4 The Tax and Accounting Expert

Tax laws can be complex and onerous. Stock options granted below fair market value may cause significant negative tax implications under § 409A.3 Change-in-control agreements may implicate the parachute payment provisions of I.R.C. § 280G and § 4999.4 Founder and key employee holdbacks in merger and acquisition transactions may raise questions of whether payments will be recognized as ordinary or capital gains income. The tax attorney or sophisticated certified public accountant is often a critical necessity in negotiations that extend beyond typical employment and severance agreements. For example, in employment negotiations during mergers and acquisitions, tax attorneys are usually a necessity for the acquirer, target, and target’s management team alike. When it comes to tax advice, some executives will prefer to rely on trusted, longtime accountants. The problem: these trusted advisors may have little experience with executive compensation matters. At other times, executives will feel comfortable relying on the employer’s tax counsel, believing that the company’s tax lawyers have no incentive to give them bad (pro-company) advice. This, of course, is not necessarily true. In complex employment negotiations, the executive should retain independent and experienced tax advisors.

§ 3.5 The Employer

Employers are the foundation of the American economy and are more diverse than many imagine. The employer may be a one-person entity, a start-up, a small business, a mid-size corporation, or a multinational behemoth. The employer may have no product or only a beta product, or it may own the market with its products. It may design computer chips, pharmaceuticals, microwave towers, or nothing at all. It may generate no revenue or billions in revenue. It may be financially sound or nearly insolvent. Despite their differences, corporate employers will be organized as business entities under the laws of their state of incorporation and required to abide by federal laws and the laws of the states in which they operate. They will also pay money, and perhaps bonuses, commissions, and equity, to their employees. Their employment agreements will “look” similar, although the content of the employment agreements may differ greatly.

3 4

26 U.S.C. § 409A; Treas. Reg. § 1.409A-1, et seq. 26 U.S.C. §§ 280G, 4999; Treas. Reg. § 1.280G-1, et seq.

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Some employers will appear to have a monolithic “way of doing things,” making it difficult, if not impossible, for the executive to pierce the “way,” although prospective CEOs are more likely than not to be able to do so. Other employers will be more fluid. Employers of certain sizes or types may have common characteristics, which, as a general matter, may provide useful insights. Others may have internal interest groups competing to be the “voice” of the employer. The employer’s geographic location may also play a role in its employment decision making. “Ways of doing things,” compensation packages, and style may differ by region. § .. the employer’s constituent interests The prospective employer is a set of human decision makers, some of whom may have competing interests or concerns, and some of whom may not be officers or directors of the company. The employer’s constituent decision-making “parts” and “interest groups” may include the employer’s board, the employer’s executive team or other senior managers, the employer’s investors/shareholders, the employer’s consultants such as compensation experts, the employer’s lawyers, and the employer’s founders. In certain situations, the “public” may be a pressure group. These constituent interests are not always aligned. Indeed, they may be at crosspurposes or in conflict. For example, the prospective employer’s founders may believe your executive client is a terrible CEO choice, while the board and investors believe he is an excellent fit. Following are some basic questions to consider when assessing the employer’s constituent interests: • What does the employer/employer’s constituent interests/other side want? • Why does the employer/employer’s constituent interests/other side want it? • How badly does the employer/employer’s constituent interests/other side want it? • What is the employer/employer’s constituent interests/other side willing to pay to get it? • What will keep the employer/employer’s constituent interests/other side from agreeing to the executive’s demands? • Who supports transacting with the executive? How strong is their support, and how badly do they want to transact? • Who opposes transacting with the executive? How strong is their opposition? Will their opposition cause the executive difficulty if a transaction takes place, and, if so, what are the risks associated with the post-transaction difficulties? • How hard can the employer/employer’s constituent interests/other side be pushed? • Will the employer/employer’s constituent interests/other side walk away from the executive’s demands? • Is there any hard evidence (e.g., the employer’s previous employment or severance agreements) to support the answers to any of these questions?

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§ 3.5.1.1 The Board and The Board’s Compensation Committee The desires of the prospective employer’s board of directors and its compensation committee (if it has a compensation committee) will often be critical during the hiring of the company’s chief executive officer and, perhaps, its most senior executives. Most public companies have compensation committees.5 They are required for companies listed on the NYSE.6 Boards and compensation committees of public employers must satisfy certain regulations that do not affect their private company counterparts. For example, effective July 16, 2011, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) prohibits national securities exchanges and associations (e.g., the NYSE and NASDAQ) from listing for sale (selling) the stock of companies which have compensation committees that do not comply with Dodd-Frank’s requirements.7 Among other obligations, Dodd-Frank requires compensation committee members to be independent (non-management) directors and gives compensation committees sole discretion to hire, set the pay for, and oversee consultants to the committee.8 Even before passage of Dodd-Frank, the SEC was increasing disclosure requirements not only for the amount of executive compensation offered by public employers but also for the process used to reach the compensation decision.9 Compensation committees of public companies sometimes retain “executive compensation experts.” In addition to retained compensation experts, a public employer’s board may be influenced by shareholder groups, shareholder advisory groups, and attorneys independently retained by the compensation committee to advise the committee.10

5

SEC Regulation S-K, Item 407(e)(1), 17 C.F.R. § 229.407 provides:

If the registrant does not have a standing compensation committee or committee performing similar functions, state the basis for the view of the board of directors that it is appropriate for the registrant not to have such a committee and identify each director who participates in the consideration of executive officer and director compensation. 6 NYSE, Inc., Listed Company Manual § 303A.05(a). 7 Pub. L 111-203, 124 Stat. 1900, § 952 (July 21, 2010) (§ 952 is effective July 16, 2011). § 952 adds the DoddFrank compensation committee requirements to § 10C of the Securities Exchange Act of 1934, 15 U.S.C. § 78, et seq. 8 Dodd-Frank § 952(a) (Securities Exchange Act of 1934 § 10C(a)(2), (c)(1)). Dodd-Frank also requires companies to pay the independent consultants hired by their compensation committees. § 952(a) (Securities Exchange Act of 1934 § 10C(e)). Dodd-Frank lists the factors to consider in determining whether a director is independent and requires the SEC to pass implementing regulations regarding committee independence. § 952(a) (Securities Exchange Act of 1934 § 10C(a)(3)). Dodd-Frank excludes certain types of companies from these requirements and requires the SEC to permit national securities exchanges and associations to exempt particular relationships. § 952(a) (Securities Exchange Act of 1934 § 10C(a)(1), (a) (4)). The SEC planned to establish implementing rules in March 2011. SEC, Implementing Dodd-Frank Wall Street Reform and Consumer Protection Act – Upcoming Activity, www.sec.gov/spotlight/doddfrank/dfactivity-upcoming.shtml (last visited Mar. 1, 2011). 9 See SEC Regulation S-K, Item 402, 17 C.F.R. § 229.402. 10 It is unclear what effect Dodd-Frank’s “say on pay” requirements will have on boards and compensation committees (and the employer’s other constituent interests). Effective January 21, 2011, § 951 of Dodd-Frank, which adds § 14A to the Securities Exchange Act of 1934, obligates public companies to

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Boards and compensation committees of private companies are generally much less constrained. The board of directors of the private company may not even have a compensation committee. For venture capital and private equity–backed private companies, compensation policies are often driven by the investors who control (or at least significantly influence) the board. § 3.5.1.2 Senior Managers The board of directors’ control over all but the most senior executive employment decisions is usually via the CEO and the company’s senior executives. The CEO and management team’s responsibility includes choosing the employees who are best able to effectively run the company. Boards of directors will usually support the employment-related decisions of the company’s CEO until the day the board fires him. This is true even if board members believe the CEO’s decision is an incorrect one. By extension, the board will usually support the hiring and firing decisions of the company’s senior executives for their subordinates, until the day those senior executives are fired. § 3.5.1.3 Investors

§ 3.5.1.3.1 Public Company Institutional Investors Many public companies’ stock is held by institutional investors. Vanguard Funds11 and California Public Employees’ Retirement System (CalPERS)12 are two examples of

hold a non-binding vote at least once every three years to approve the executive compensation of the employer’s Named Executive Officers (“NEOs”). (Securities Exchange Act of 1934 § 14A(a)(1); 15 U.S.C. § 78, et seq.). NEOs are a public company’s CEO, CFO, three highest paid executives other than the CEO and CFO, and up to two additional non-executives who are paid at least as well as one of these five executives. 17 C.F.R. § 229.402(a)(2)-(3). At least once every six years, public companies must also ask their shareholders whether they would like to vote on the NEOs’ compensation every year, every other year, or every third year. Dodd-Frank § 951 (Securities Exchange Act of 1934 § 14A(a)(2)). According to § 951, the result of the non-binding votes do not affect the board’s fiduciary duties, although it is unclear whether courts interpreting state fiduciary law will reach this conclusion. (Securities Exchange Act of 1934 § 14A(c)). See § 8.2.8 for a discussion of the business judgment rule and directors’ fiduciary obligations. The SEC adopted implementing “say on pay” regulations on January 25, 2011. See Shareholder Approval of Executive Compensation and Golden Parachute Compensation, Securities Act Release No. 33-9178, Exchange Act Release No. 34-63768 (Jan. 25, 2011), available at http://www.sec.gov/rules/ final/2011/33-9178.pdf. Companies accepting Troubled Asset Relief Program (TARP) funds were previously required to include “say on pay” resolutions in their annual proxy statements. 12 U.S.C. § 5221(e). See § 8.2.7 for a more detailed discussion of TARP’s effect on executive compensation. 11 Vanguard owned almost $600 billion in common stock and voted for more than 20,000 directors at approximately 4,000 companies in the year ending on June 30, 2009. Vanguard describes its corporate governance philosophy at Vanguard, Our Views on Corporate Governance, https://personal.vanguard. com/us/content/Home/WhyVanguard/AboutVanguardCorpGovernPrinciplesContent.jsp. 12 CalPERS describes its corporate governance philosophy at CalPERS Corporate Governance, www. calpers-governance.org.

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institutional investors. The major stockholders of a public company are public information. For the most part, institutional investors will support the compensation committee’s compensation decisions. However, on certain hot-ticket executive compensation issues, institutional investors may pressure the board, either directly or indirectly, especially when their advisors take positions on employment practices. Institutional investors may rely on the recommendations of independent third-party experts when deciding how to vote their shares in a company election. Institutional Shareholder Services Inc. is the gorilla in the independent third-party voting advice industry.13 § 3.5.1.3.2 Private Company Investors Private company investors are often an entirely different breed than the public company’s institutional investors. Private company investors range from self-funded founders to angel investor groups to venture capital investors to strategic investors (e.g., a joint venture partner doubling as an investor) to private equity investors. Many private investors sit on the boards of the companies in which they invest. Private company investors, particularly those sitting on the board, vary widely in their proclivities toward the executives and entrepreneurs in their portfolio companies. Some are inclined to fire entrepreneurs at the drop of a hat, repurchasing their unvested equity whenever possible. Some seem to believe they can do a better job running a company than most of the executives they hire. Some attempt to replicate a management team formula (generally hiring experienced executives who have done it before) wherever they invest. Some will give great deference to the management team in place. Investors may have personal or institutional interests that trump the best interests of the company, management, or stockholders as a whole. There are numerous possible permutations of self-interest. The key for the executive’s attorney is to understand who the investors are and, as much as possible, what drives them. Under Delaware law, all board members owe “unremitting” fiduciary duties of “due care, good faith and loyalty” to both the corporation and its shareholders.14 Their fiduciary duties require board members to look out for the best interests of all of the company’s common shareholders, not just one group of them.15 But that is not always what happens. Board members representing founder investors, angel investors, venture capital investors, strategic partner investors, and private equity investors may have

13

Institutional Shareholder Services Inc., www.issgovernance.com. Institutional Shareholder Services Inc. is owned by MSCI Inc. 14 Malone v. Brincat, 722 A.2d 5, 10 (Del. 1998). 15 Under Delaware law, directors owe fiduciary duties to the common stockholders but to preferred stockholders only insofar as the duties to the preferred stockholders are owed to the common stockholders. Jedwab v. MGM Grand Hotels, Inc., 509 A.2d 584, 594 (Del. Ch. 1986). In Delaware, rights of preferred stockholders are primarily contractual and equitable in nature. Rothschild International Corp. v. Liggett Group, Inc., 474 A.2d 133, 136 (Del. 1984).

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investor-specific interests and concerns that trump the best interests of all of the company’s stockholders. Venture capital or private equity investor-appointed board members may look out first for the interests of their investment funds (their investors) rather than for the best interests of all of the company’s stockholders as a whole. To make things more complex, preferred equity board member investors sometimes have political and other concerns vis-à-vis the equity funds they manage, which take precedence over the best interests of the company’s shareholders as a whole and even, perhaps, the best interests of the preferred stockholders who elected that board member. Take, for example, a venture capitalist board member whose investment fund purchased preferred stock in a company and whose investment fund has suffered significant losses over the years. That board member may be faced with reporting negative returns to his fund’s investors. Reporting negative returns to his fund’s investors, in turn, may hurt that board member’s ability to attract investors into later funds. Thus, when an acquisition offer comes in where most economic models would call for a sale of the company, the board member may vote “no deal.” That venture capitalist board member may vote “no deal” to “go long,” a decision to risk everything for the possibility that the company might someday go public, garnering gigantic returns for the preferred investors. Doing so might turn a losing venture capital fund into a moneymaking fund and make the board member a success, rather than a failure, to his venture capital fund investors. § 3.5.1.4 Founders as an Employer’s Constituent Interest When it comes to their companies, founders may want what is in the best interests of all the shareholders, in part because those interests are aligned with theirs. However, founders often have their own goals and interests, which may have little to do with the best interests of all of the shareholders. Unfortunately, all too often, founders make irrational and emotional decisions. That a founder is excellent at creating and incubating companies in their incipient stages does not mean he is the right person to manage companies in the later stage of their corporate life. Some founders are outstanding managers. Others are awful leaders. The problem is that the founder may not realize or care that he is a poor manager. This may be particularly problematic when the founder controls a significant portion of the employer’s stock or a majority of its board. For example, the unchecked founder may manage the company as his personal fiefdom, surrounding himself with sycophants and “yes” men, thereby inhibiting the company’s ability to grow. Consequently, founders may be the most difficult of the employer’s constituent interests. Founders have made companies. They have driven once-successful companies into mediocrity. And they have destroyed their companies because they did not know when it was time to let go.

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§ 3.5.1.5 Attorneys for the Employer’s Constituent Interests The employer may have in-house counsel (e.g., general counsel, vice president of legal) and/or outside counsel involved in the executive’s negotiation. While attorneys representing one or more of the employer’s constituent interests probably will not be involved in most “standard” executive employment and separation negotiations, in more complex transactions, such as corporate financings and mergers and acquisitions, count on the presence of attorneys representing the employer’s constituent interests. As with any counsel, some of the lawyers representing the employer’s constituent interests will be better than others. In certain situations, savvy lawyers will be the reason a deal takes place, while in other circumstances the attorneys will cause the transaction’s demise. Sometimes the constituent interests’ attorneys’ desires to keep their clients happy (to ensure continuing work flow) runs at cross-purposes with their clients’ goals. You, as the executive’s attorney, may not be able to do anything about this, but it is important to understand that the dynamic may occur and important to consider how the dynamic may affect the executive’s negotiation. The job of employer’s counsel is to zealously advocate for the corporation, which may cause the executive hurt feelings, especially during back-end severance negotiations, or if corporate counsel is directed to go to war with the executive. Before facing off against an executive they know well, however, most corporate counsel will refer their company’s ex-management team member to a leading executive lawyer in their area.

§ .. the corporate employer’s size, location, industry, and stage of development The prospective employer’s size, industry, location, and stage of development, among other factors, may be an important consideration in both the executive’s decision to engage with the employer and the employer’s willingness to provide one or more types of compensation or incentives. It is important to remember that start-ups are not all the same, mid-size companies may differ greatly by sector, and public companies may be smaller than the largest private companies or huge, multinational enterprises. For example, on the start-up end of the spectrum, $15 million in venture financing for a one-product software start-up may be a substantially greater investment vis-à-vis the software start-up’s needs as compared to $15 million in venture financing for a chip manufacturing start-up. The percentage of equity these two start-ups are willing to provide their new CEOs may differ based on the start-ups’ capital structure and future financing needs. On the large, mature company end of the spectrum, according to The Wall Street Journal, the median direct total compensation in 2009–2010 for CEOs running health

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care and oil and gas companies with at least $4 billion in revenue was $10.4 million.16 The median compensation for CEOs running similar size technology companies was $7 million.17 For CEOs directing consumer service companies, median CEO compensation was $3.4 million.18 An employer’s location may also affect the executive employment negotiation. For example, a California-based employer will not request any of its employees to sign a non-compete agreement, whereas an equivalent employer in another state may demand an onerous non-compete agreement as a condition to entering into an employment relationship.19

§ 3.6 Outside Consultants

There are many types of outside consultants. Two of the most important for executive employment-related matters are executive search firm consultants and compensation consultants. § .. the executive search firm Many executive search firms are hired by a prospective employer for a “retained search” to locate a candidate for a particular position at the company. For example, an employer’s board might retain an executive search firm to find the company’s new chief executive officer. A good executive search firm works very closely with its corporate client to locate the right candidate for the right position. The search firm may spend hours interviewing company managers to determine the type of executive (attributes, experience, style) the employer desires to hire. The retained executive search firm will usually indentify multiple candidates for the open position and refer those candidates to the company for interviews and consideration. Typically, the executive search firm earns some percentage of the executive’s first-year salary (or other compensation) when the open position is filled.

16

Hay Group, Wall Street Journal Survey of CEO Compensation, Wall St. J., Nov. 14, 2010, http:// graphicsweb.wsj.com/php/CEOPAY10.html; See also Hay Group, Executive Pay—A New World Order Or Business As Usual? Wall St. J./Hay Group 2009 CEO Compensation Study (April 2010), available at www.haygroup.com/Downloads/ww/misc/2009_WSJ_11x17_brochure.pdf. A chart with industry-wide median compensation data and a chart reporting the components of compensation that are not in the report is available at www.haygroup.com/Downloads/ww/misc/WSJ_Hay_Group_200_-_Industry_ Median_Data.pdf. 17 Hay Group, Wall Street Journal Survey of CEO Compensation, Wall St. J., Nov. 14, 2010, http:// graphicsweb.wsj.com/php/CEOPAY10.html. 18 Id. 19 See the discussion on non-compete agreements in Chapter 10.

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There are numerous executive search firms in the country, some of which specialize by industry or job position. Russell Reynolds Associates,20 Korn/Ferry International,21 and Egon Zehnder International22 are three examples of executive search firms.23 § .. compensation experts Compensation committees or boards of public companies, and an increasing number of private companies, frequently retain compensation experts to advise them on executive compensation matters.24 Frederic W. Cook & Co., Inc.,25 Compensia, Inc.,26 Pearl Meyer & Partners,27 and ExeQuity LLP28 are some examples of consulting firms specializing in executive compensation matters. These companies research executive compensation practices and advise the would-be employer about prevailing compensation trends in the relevant sector.29 In the past, executive compensation experts advising company boards and compensation committees were often the same large consulting firms advising management on human resource issues. However, the dual-role consulting may be going out of favor. Because of increasing concern about the conflicts of interest inherent in advising both management and the board, and recent SEC changes in disclosure obligations, more independent boards appear to be insisting that board consultants do no other work for the company.30 Furthermore, for annual meetings

20

Russell Reynolds Associates, www.russellreynolds.com. Korn/Ferry International, www.kornferry.com. 22 Egon Zehnder International, www.egonzehnder.com. 23 An incomplete list of executive search firms, as well as additional information on executive searches, may be found at The Riley Guide, Executive Search Firms, www.rileyguide.com/firms.html. 24 SEC rules require public employers to identify their compensation consultants. 17 C.F.R. § 229.407(e) (3)(iii). 25 Frederic W. Cook & Co., Inc. www.fwcook.com. Frederic W. Cook & Co., Inc. tracks executive compensation trends and practices at select classes or groups of employers and often posts reports on these trends on its website. 26 Compensia, www.compensia.com. 27 Pearl Meyer & Partners, www.pearlmeyer.com. 28 ExeQuity, www.exqty.com. 29 Executive search firm J. Robert Scott sells executive compensation data on its Web site at www. compstudy.com. 30 See Joann S. Lublin, More Boards Opting for Independent Pay Advisors, Wall St. J., Jan. 11, 2010, available at http://online.wsj.com/article/SB10001424052748703535104574646823950331160.html. 21

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occurring after July 16, 2011, § 952 of Dodd-Frank requires company proxy materials to disclose whether the employer’s compensation committee retained a compensation consultant as part of its decision-making process, whether any conflicts of interest exist with respect to the compensation consultant, and, if a conflict exists, actions taken to address the conflict. 31

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Dodd-Frank § 952 (Securities Exchange Act of 1934 § 10C(c)(2)). § 952 of Dodd-Frank also prohibits compensation committees from hiring consultants, attorneys, and other advisors without taking into account various factors, including the extent of the advisor’s firm’s involvement with company managers, the amount of income the advisor’s firm receives from the company as a percentage of the advisor’s firm’s total revenue, the advisor’s firm’s policies and procedures to prevent conflicts of interest, the advisor’s business and personal relationships with compensation committee members, and the amount of company stock the advisor owns. (Securities Exchange Act of 1934 § 10C(b)(2)). The SEC is required to pass implementing regulations and may add other factors which compensation committees must consider when hiring consultants. Id. The SEC planned to establish implementing rules in March 2011. SEC, Implementing Dodd-Frank Wall Street Reform and Consumer Protection Act – Upcoming Activity, www.sec.gov/spotlight/dodd-frank/dfactivity-upcoming.shtml (last visited Mar. 1, 2011).

4 A BR I E F D E SC RI PTION OF THE DOCU M E NTS

the purpose of this chapter is to briefly introduce the more common deal documents you will see while representing your executive and entrepreneur clients. Some of these documents (or clauses contained in them) are discussed at greater length later in this book, and some examples are included in the appendices of later chapters.

§ 4.1 Offer Letter

The offer letter is a letter from the prospective employer offering employment to the executive. Offer letters comes in many types and sizes. They may be one page or many pages. They may be sparsely written or include all the terms usually found in a sophisticated “employment agreement.” The offer letter is almost always a contract for employment. Many offer letters, however, state that employment is at will, which means the employment contract may be terminated by either party at will, with or without cause, with or without notice, and for any reason or no reason at all (except an illegal one). Without more, the offer letter is not much of a contract. But with the protections (severance, accelerated vesting, and so forth) the executive requires, the offer letter is a critical contract that may be worth millions of dollars. Sometimes the offer letter states, on its face, that it is not a contract for employment. However, if the executive signs the offer letter, and the employer signs the offer letter, and both intend that the document describes the terms of the executive’s 34

A Brief Description of the Documents

35

employment, then the terms in the offer letter are the contract. For this reason, the offer letter must contain all the employment-related protections the executive requires.1

§ 4.2 Employment Agreement

An employment agreement is a formal contract for employment between the executive and employer. Functionally, there is no difference between an “employment agreement” and a well-drafted “offer letter.” The employment agreement may look fancier or more complete. It may have more bells and whistles. But at the end of the day, what matters to the executive are the terms and conditions of his employment and the benefits he receives when his employment terminates. The important terms, conditions, and benefits are written as easily into an “employment agreement” as into an “offer letter” and vice versa.

§ 4.3 Commissions and Bonus Plans

Sales executives are often incentivized by commission payments. Commissions are sales-based compensation payments (e.g., the more sales, the more commission paid). Executives of all types may earn bonuses. Bonuses are sometimes based on objectives, metrics, or milestones, but at other times, they are completely discretionary, and at still other times, contain both a discretionary and objective component. The terms and conditions of an executive’s commission or bonus may be individualized and set forth in the offer letter or employment agreement. Frequently, however, the executive participates in an employer-approved bonus or commission plan. There are many types of bonus and commission plans, and payments are triggered by a host of different milestones and management-based objectives.

§ 4.4 Equity Agreements

You may see various equity agreements while representing executive and entrepreneur clients. The equity agreements sometimes carry different names but should be readily identifiable from the descriptions in this book. For public companies that have adopted

1

The offer letter should contain all material terms of the employment relationship, including all protective clauses, even if the executive and employer intend to replace the offer letter with a more formal employment agreement. This is so, in part, because the executive will probably have the strongest negotiating leverage before he joins the employer, and, in part, because the parties may be too busy in the first weeks or months (or even years) of the employment relationship to focus on drafting a follow-on agreement.

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equity agreements, forms of the agreements are publicly available. Private companies with board- and shareholder-approved equity plans will make their equity-related documents available during employment negotiations. Public companies are increasingly using online brokerage houses (e.g., E-Trade or Charles Schwab) to manage their employee equity grants and agreements. Consequently, certain documents described below may be accessible by clicking on the appropriate link in the employee’s online brokerage account. § .. founders’ restricted stock purchase agreement The founders’ restricted stock purchase agreement (RSPA) is the contract by which a start-up company sells the company’s founder a certain amount of the company’s stock. The stock is almost always common stock and “purchased” by the founder for a nominal amount (because at the company’s formation, the company is usually worth very little). Frequently, the RSPA provides that the founder owns the stock, but some or all of the shares are subject to repurchase by the company (usually at the same price the founder paid for the shares) if the founder’s service to the company terminates. Typically, the founder’s right to own the stock free and clear vests over time (the company’s repurchase right lapses over time).2 In addition, the founder usually files an I.R.C. § 83(b) election with respect to the unvested stock.3 § .. employee stock option agreement The employee stock option agreement is a contract granting the employee an option to purchase a fixed amount of an employer’s stock at a fixed price (the exercise price).4 The per share exercise price of the option is typically the fair market value of a share of common stock of the employer on the date of grant. The employee stock option may be an incentive stock option or a nonqualified stock option.5 Employee stock option agreements are almost always issued pursuant to, and subject to, the employer’s equity plan, described below. Employee stock options typically vest, which means at some point after the option is granted, the employee acquires the right to exercise the option (the right to purchase the shares of stock underlying the option). Vesting is either time-based or performance-based (sometimes it is a combination of both methods). With a time-based vesting stock option, the employee’s right to exercise the option and purchase the company’s stock vests over a period of time, providing the employee remains employed by the company. By contrast, with performance-based stock options, the employee’s

2

See description of vesting in §§ 4.4.2, 7.4.6.2. See discussion in § 7.4.6.10 regarding § 83(b) elections. 4 The exercise price is sometimes referred to as the “strike price.” 5 Incentive stock options and non-qualified stock options are discussed at § 7.4.6.12. 3


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right to exercise the stock option and purchase the company’s stock vests when the predetermined performance milestones described in the stock option are achieved. § .. employee restricted stock unit agreement The restricted stock unit agreement is a contract granting the employee restricted stock units (RSUs). RSUs are, essentially, shares of an employer’s common stock that are reserved for issuance to the company’s employee. RSUs typically vest. As with employee stock options, RSUs may vest over time or vest based on performance. Unlike a stock option, which grants the employee the right to purchase company stock once the option vests, the restricted stock unit agreement guarantees delivery of the company’s stock once the RSU vests. Restricted stock unit agreements are usually issued pursuant to and subject to the employer’s equity plan. § .. notice of stock option grant or notice of restricted stock unit grant The notice of stock option grant or notice of restricted stock unit grant is usually a oneor two-page document by which an employer notifies an employee that it has granted the employee a stock option or restricted stock unit agreement. The notice of grant typically contains language that incorporates by reference the terms of the employer’s stock option agreement (or restricted stock unit agreement) and equity plan. § .. employer’s equity plan The employer’s equity plan is a formal governing document authorizing the company to issue equity (and perhaps, phantom equity) to employees (and consultants). It is approved by the company’s board of directors and stockholders. § .. other employee equity arrangements § 4.4.6.1 LLC Unit Option Agreement Limited liability companies (LLCs) typically issue, if they issue anything at all, membership interests or units. Consequently, if the executive works for an LLC, he or she may receive an LLC unit option agreement. Functionally, the LLC unit option agreement operates similarly to the employee stock option agreement discussed above.6

6

The executive may also receive a profits-interest or other agreement that seeks to combine the equity and phantom equity characteristics of an LLC unit option agreement and phantom equity agreement.

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§ 4.4.6.2 Phantom Equity Agreement A phantom equity agreement is a contract that attempts to capture the economic performance of a stock option or RSU (or other equity grant) without granting any equity. It is a false equity arrangement (or phantom arrangement), which typically pays the employee the amount of money that the employee would have earned had he or she held a substantially similar stock option, restricted stock unit agreement, or equity contract. It is used by employers who do not want to grant equity in their entity, but who, at the same time, desire to reward employees when the value of their entity grows. Stock appreciation rights (SARS) are a form of phantom equity that some employers use to compensate their employees. SARS attempt to mimic the return to employees that would be realized by an equivalent stock option grant, without offering the underlying equity. SARS are usually granted by an employer’s board (or committee of the board) pursuant to an equity plan established by the employer. A Notice of SARS Grant and a SARS Agreement may accompany the grant. § 4.4.6.3 Employee Stock Purchase Plan (ESPP) The employee stock purchase plan (ESPP) is a plan that public companies may adopt under § 423 of the Internal Revenue Code.7 Employers use the ESPP to create an option that allows employees to purchase an employer’s stock, typically with payroll deductions, over a set offering period. The employee must elect to participate in the plan at the beginning of the offering period.8 ESPP plans differ by employer. Depending on the plan, an ESPP may offer employees the ability to purchase their employer’s stock for up to a 15 percent discount off the fair market value of the stock.9 The stock price is measured either on the last day of the six-month offering period, or, if the employer’s ESPP plan has a “look back” provision, and the stock price was lower on the first day of the offering period, the first day of the offering.10 Employees are limited to purchasing $25,000 in ESPP stock per year, although a plan may contain a lower limit.11

7

26 U.S.C. § 423. 26 U.S.C. § 423(a)(2). 9 26 U.S.C. § 423(b)(6). 10 Id. 11 26 U.S.C. § 423(b)(8). When the $25,000 is measured depends on the plan. See Treas. Reg. § 1.423–2 Employee Stock Purchase Plan Defined, 74 Fed. Reg. 59,078, 59,084 (Nov. 17, 2009). ESPP-related earnings can be taxed in a variety of ways depending on the circumstances. Intuit’s Web page contains an explanation of the taxes that may be applicable to gains from ESPP shares; see TurboTax, Employee Stock Purchase Plans, http://turbotax.intuit.com/tax-tools/tax-tips/investments-andrental-property/5595.html. 8


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§ 4.4.6.4 Employee Stock Ownership Plan (ESOP) The employee stock ownership plan (ESOP) is a defined contribution benefit plan that permits employees to purchase shares of their employer.12 It is established pursuant to the ERISA.13 ERISA plan documents will be available to all company employees (and prospective employees).

§ 4.5 Confidential Information and Invention Assignment Agreement

The confidential information and invention assignment agreement (CIIAA) goes by many names, but its central purpose is to contractually guard the employer’s confidential and proprietary information and trade secrets, and to ensure the assignment to the employer of all intellectual property developed during employment.14 The CIIAA typically contains a section describing the employee’s confidentiality obligations with respect to the employer’s confidential and proprietary information and trade secrets, a section requiring assignment to the employer of inventions and copyrights created by the employee in the course and scope of employment, and a disclosure section requiring the employee to disclose all of the employee’s preexisting inventions and proprietary information (to make clear which intellectual property existed before the employment relationship and thus belongs to the employee or a third party). CIIAAs for California employees also must contain a California Labor Code § 2870 disclosure. The California statute provides that an employee owns intellectual property unrelated to the employer’s business that he creates on his own time, without use of his employer’s facilities or resources.15

12

26 U.S.C. 4975(e)(7). 29 U.S.C. § 1001, et seq. 14 Other names for the CIIAA include “confidentiality agreement,” “confidential information agreement,” and “confidentiality, invention assignment and proprietary information agreement.” In some cases, employers may label their CIIAA “employment agreement” even if the document contains only confidentiality, invention assignment, and proprietary information-related clauses. 15 Cal. Lab. Code § 2870 provides: 13

(a) Any provision in an employment agreement which provides that an employee shall assign, or offer to assign, any of his or her rights in an invention to his or her employer shall not apply to an invention that the employee developed entirely on his or her own time without using the employer’s equipment, supplies, facilities, or trade secret information except for those inventions that either: (1) Relate at the time of conception or reduction to practice of the invention to the employer’s business, or actual or demonstrably anticipated research or development of the employer; or (2) Result from any work performed by the employee for the employer. (b) To the extent a provision in an employment agreement purports to require an employee to assign an invention otherwise excluded from being required to be assigned under subdivision (a), the provision is against the public policy of this state and is unenforceable.

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CIIAAs frequently contain clauses one might not expect to find in a confidentiality and intellectual property agreement, and for this reason must be carefully reviewed before employment begins. CIIAAs regularly contain at-will employment clauses, nonsolicitation of employee clauses, and, sometimes, overarching arbitration clauses.

§ 4.6 Change in Control Agreement

The change in control agreement sets out the benefits and the protections the executive or entrepreneur will receive in the event the employer undergoes a corporate change in control, such as a merger or asset sale. Many change in control agreements provide that benefits will be triggered only if the executive’s employment terminates after the corporate change in control.

§ 4.7 Retention Agreement

The retention agreement describes the benefits the employee will receive if he remains an employee of the employer through a particular date or event. Retention agreements are used in a wide variety of circumstances by employers that have undergone, or expect to undergo, a significant corporate event. For example, an employer may offer a $200,000 “retention bonus” if the executive is employed by the company a year after the retention agreement comes into force. In the case of a corporate liquidation, the employer (or an affiliate of the employer) may offer the same size retention bonus if the executive is employed on the day the company liquidates.

§ 4.8 Management Carve-Out Agreement

The management carve-out agreement is a contract that typically reserves some portion of the sale price of an employer for management. It is a form of retention agreement.

§ 4.9 Non-Compete Agreement

The non-compete agreement restricts an employer’s ex-employee from competing against the employer or one or more businesses of the employer. The enforceability of employee non-compete agreements, including the permissible scope and geographic reach of the non-compete restrictions, are a function of state law, often as interpreted by the relevant state’s courts. States differ on the scope of permissible employee non-compete agreements.


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California-based executives will almost never be asked to sign a non-compete agreement unless their employer is sold. Non-competition agreements are unenforceable in California, except in limited specifically defined circumstances.16

§ 4.10 Arbitration Agreement

The arbitration agreement typically requires the employee (and employer) to resolve most, or all, disputes between them in binding arbitration. By signing the arbitration agreement, the parties waive their right to a trial by jury and right to judicial resolution of disputes. Frequently, the arbitration agreement allows one or both parties to use the courts to obtain extraordinary relief, such as an injunction, to prevent threatened or actual harm (e.g., the disclosure of trade secrets). JAMS17 and the American Arbitration Association18 are the two largest arbitration providers in the United States.

§ 4.11 Indemnification Agreement

The indemnification agreement is the contract by which the employer indemnifies the executive from and against everything (or most everything) that he can legally be indemnified against, including most alleged acts and omissions committed by the executive in the course and scope of his service to the company. Indemnification agreements are board approved and frequently offered to all of a company’s directors and senior officers. Indemnification agreements usually contain a clause obligating the employer to advance all costs and expenses, including attorneys’ fees, to the officer or director in the event that a claim or lawsuit is brought against, or an investigation is begun regarding, the employee. This critical clause protects the executive if he is someday joined as a defendant in an expensive company litigation, such as a class action case, which may cost tens of millions of dollars to defend.

§ 4.12 Employee Benefit Plans

Companies often offer an assortment of employee benefit plans to their employees, such as medical and dental plans, life insurance plans, disability plans, and retirement plans. Links to the plans may sometimes be found on an employer’s intranet site.

16

Cal. Bus. & Prof. Code § 16600; see discussion in Chapter 10. JAMS Arbitration, Mediation, and ADR Services, www.jamsadr.com. 18 American Arbitration Association, www.adr.org. 17

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The would-be employer will almost always provide descriptions or copies of its employee benefit plans during employment negotiations. Because these plans have been previously approved by the prospective employer and offered to multiple qualifying employees, they are not individually negotiated. Usually, they are simply referenced, rather than described in detail or attached as exhibits, to the offer letter or employment agreement.

§ 4.13 Employee Handbook and Company Policies

The employee handbook is a document that contains the employer’s policies. The employee handbooks of many mature employers may be found on the employers’ intranet sites. As with the employer’s employee benefit plans, the employee handbook is a pre-existing document which may be referenced, but usually is not attached as an exhibit to the offer letter or employment agreement.

§ 4.14 Separation (Severance) Agreement

The separation (severance) agreement between the executive or entrepreneur and the former employer (or soon-to-be former employer) is the contract that memorializes the separation-related terms between the employee and the employer. Unlike the employment agreement or offer letter that are negotiated at the outset of the employment relationship and that may contain separation-related protection, such as a severance pay requirement, the separation agreement is usually negotiated at the end of the employment relationship or shortly after the relationship ends. The separation agreement typically includes employer-provided benefits and payments and the executive’s or entrepreneur’s release of the employer.

§ 4.15 Loans to Executives

Employer-provided loans (promissory notes) for executives are much less common than in the past because the Sarbanes-Oxley Act of 2002 did away with no-interest-rate or below-market-interest-rate loans in public companies.19 In turn, private companies hoping one day to go public or sell themselves to a public company have done away with most of these loans as well. Nevertheless, company-provided promissory notes to private company executives are legal under many circumstances and, therefore, continue to exist.

19

sarbanes-oxley act of 2002 § 402, 15 U.S.C. § 78m(k).


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§ 4.16 Performance Improvement Plan

The Performance Improvement Plan, or PIP, which goes by a number of different names and acronyms, is a plan ostensibly used by an employer to set out all the performance objectives a “failing” employee must meet to retain his job. PIPs usually establish a deadline for improved performance. For example, a PIP might require proof of improved performance in 30 different performance areas within 90 days.

§ 4.17 Consulting Agreement

The consulting agreement is the contract describing the terms and conditions under which a non-employee consultant provides services to a company.

§ 4.18 Corporate Governance Insurance Policies

There are three basic types of insurance policies that cover executives for acts and omissions they commit, or are alleged to commit, while serving as officers and directors: directors and officers insurance (D&O insurance), employment practices liability insurance (EPL insurance), and errors and omissions insurance (E&O insurance). D&O policies insure a company’s officers and directors against claims that they breached their fiduciary duties or committed other corporate governance wrongdoing in the course and scope of their service to the company. EPL policies protect officers in the event of an employee lawsuit against the executive, acting in his role as manager, for alleged wrongful conduct, such as illegal discrimination. E&O policies insure a company and its executives against third-party business claims. Insurance policies may be purchased in multiple layers or multiple tiers. For example, an employer may have 10–10–10 D&O coverage. This means the employer has purchased a $10 million primary D&O insurance policy, a second $10 million excess D&O insurance policy with coverage that kicks in if the first $10 million in coverage is exhausted, and a third $10 million excess D&O insurance policy with coverage that kicks in if the first two $10 million policies are exhausted.

§ 4.19 Capital Investment in the Private Company Employer: Financing Documents and Related Agreements

§ .. preferred stock Corporations issue stock. Start-ups and private companies typically issue their employees (i) common stock and/or (ii) employee stock options for common stock.

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Investors, particularly sophisticated angel investors, venture capital investors, or private equity investors, usually receive preferred stock in return for their capital investments. Preferred stock provides the investors certain preferred rights over common stock. Corporations may issue multiple series of preferred stock: for example, series A preferred stock, series B preferred stock, series C preferred stock, and so forth. Sometimes a preferred stock series may itself be subdivided: for example, series A-1 preferred stock and series A-2 preferred stock. Each series and subseries of preferred stock may contain distinct rights, of which the most important are usually dividend rights, conversion rights, and liquidation preferences. Terms such as “double participating preferred” and “guaranteed dividend,” when used in connection with investor-backed private companies, usually refer to the rights of the preferred investors as reflected in their preferred stock purchase agreements. The key rights and preferences of most private employers’ common and preferred stock are publicly available. For example, the Certificate of Incorporation of a Delaware company is publicly available and will disclose the equity configuration of the corporation and important rights and preferences of the company’s preferred stock.20 These rights and preferences, as well as the agreements that comprise a private company’s capital financings, may be critical to the executive’s employment-related negotiations, and for this reason you and your executive client must thoroughly understand them before the executive agrees to join a prospective employer. The financing documents may affect corporate governance and thus, the executive’s ability to affect corporate governance and decision making. They may also affect the “value” to the executive of his equity. For example, financing documents may highlight the potential risk of dilution to the equity. As another example, the investment agreements may significantly affect the amounts the executive will earn from his equity in the event the company is sold. Some of the more common investor-company agreements are briefly discussed in the sections below. § .. stock purchase agreement The stock purchase agreement is the contract by which investors agree to pay money (capital) to a company in return for some number of shares, usually preferred shares of

20

The Delaware Secretary of State accepts fax requests for copies of Delaware corporations’ Certificates of Incorporation at 302-739-3813. Delaware charges $10 for the first page and $2 for each additional page. If you would like to know the number of pages before requesting copies, call 302-739-3073. Other states take different approaches to providing copies of corporate documents. For example, the California Secretary of State accepts requests for copies of California corporations’ Articles of Incorporation only by mail and in person. California charges $1 for the first page copied and $.50 for every additional page. The California Secretary of State’s address is 1500 11th Street, Sacramento, California 95814. As another example, Colorado’s Secretary of State provides free copies of Colorado corporations’ Articles of Incorporation at www.sos.state.co.us. From there, click on “Business Division,” then click on “Search business database.” Thereafter, enter the name of the Colorado corporation of interest.


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stock, of the company. The stock purchase agreement will set out the price and rights and preferences of the preferred stock. § .. investor agreement The investor agreement contractually binds investors and the company (and perhaps others) to certain rights, obligations, and restrictions. For example, an investor agreement may provide all preferred stock investors with “tag along” rights, which is the right to sell their equity in the event another investor or founder sells equity to a third party. § .. voting rights agreement The voting rights agreement contractually binds signatories to vote their shares in the specific ways set forth in the agreement. Voting rights agreements may be used to guarantee investor representatives seats on a company’s board of directors. § .. registration agreement The registration agreement requires the company to register the company’s stock under certain conditions so the stock may be publicly sold on a stock market. Registration rights come in multiple forms (e.g., demand registration rights, piggyback registration rights).21 Private company investors frequently demand registration rights as a condition of their investment. § .. bridge loan (bridge financing) The bridge loan is the loan agreement by which an investor loans money to a company to finance the company (bridge the company) between significant corporate events, usually corporate financing or capital raising events. The convertible bridge loan obligates an investor (or other financier) to loan money to a company, and in return, the investor obtains the right to receive interest and principal payments or convert the loan into equity securities of the company at an agreed-on value or event. § .. warrants A warrant is a contract that gives the warrant holder the right to pay a fixed price (the warrant exercise price) for a fixed period of time to purchase a specific amount of

21

Demand registration rights provide the holder the right, under certain circumstances, to require the company to register the holder’s stock for sale on the public markets. Piggyback registration rights provide the holder the right to require the company to register the holder’s stock for public sale in the event the company registers other stock for public sale.

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company stock. Warrants may contain restrictions or be triggered by certain events. They are similar to stock options, although they do not usually require the warrant holder to work for a company, nor are they issued pursuant to an employer’s equity plan. In private companies, particularly start-ups, investors may receive warrants in return for investments or loans, while service providers and others (e.g., marketing consultants, banks, or landlords) may receive warrants as partial payment for services rendered.

5 T H E E X E C UT I VE B E COM E S A CL IE N T — THE AT TO R N E Y B E GI NS TO A DV I SE

§ 5.1 The Initial Contact

§ .. the intake If you have an active practice and speak with every new inquiry who calls your office, you might never finish what you are doing. On the other hand, if you focus exclusively on your existing work, you risk losing new clients because your response to them is delayed. The solution: hire an “intake” assistant to screen first-time callers. When the initial call comes into your office, the intake assistant should mini-interview the prospective client, and then write a short statement of a few paragraphs about the prospective client’s story for your review. The assistant’s intake work will give you some idea of your prospective client’s situation before you speak with him. The intake assistant must be a good listener and know how to talk to people. He need not be a lawyer, or even good at many things, but he must be comfortable asking questions that some find difficult (What is your salary? Why were you fired?), listening at length to the personal stories of people he has never met, and writing everything down. The intake assistant should be able to listen calmly to both the problems of a just-fired minimum wage worker and Mr. Multi-Millionaire’s explanation of his $10 million loss. A good intake assistant should be able to give you a heads-up on which “intakes” you will want to call back immediately. He should also be able to help you avoid spending excessive time on those you probably will not be able to assist or may not want as clients. 47

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§ .. the telephone interview The vast majority of fast-paced executives and entrepreneurs do not care where you live, where you practice, or where you are when they call you. This is especially so when the executive has been referred to you by someone he respects. Frequently, the executive has no interest in meeting you, even if your office is nearby. Time, after all, is money. Executive clients care about results. And they care about getting answers quickly. This often means that they want to tell you everything immediately and over the phone. The “intake” from your assistant should give you an idea of the potential client’s situation before you speak with the new inquirer. If the intake is promising, you will probably want to follow up with the potential client as fast as reasonably possible. This usually means a phone call. The “intake” from your assistant grounds you during the initial call. During your initial conversation with the prospective client, do not worry about remembering everything you hear. This is the time to assess your potential client, learn something about his situation, and determine whether you are a good fit for him (you may not want to represent him for any number of reasons). At the same time, the initial telephone conversation is the time your potential executive client sizes you up to determine whether he wants to move forward with you. All practitioners will lose some potential clients after the initial telephone call. However, if you are losing significant numbers of potential clients after the initial call—particularly if those potential clients have been referred to you—then take time to assess what is happening on the calls and how you are presenting yourself. Executives frequently request legal advice during the initial call, even before they become a client. Resist the temptation. Do not give legal advice over the telephone to people who are not your clients, for many reasons, the most important of which is that invariably, you will not have sufficient information to give decent legal and business advice. Reread the last sentence. It is better to lose a potential executive client than to give advice when you have insufficient information to render it. The danger of disservice is even greater when the prospective client is agitated or emotional—people often hear what they want to hear, not what the lawyer tells them over the phone. You should take four steps before giving legal advice to a client. First, ensure the prospective client reviews and signs your fee agreement. Second, make sure the would-be client sends you a retainer. Third, obtain a full chronology of events from the new client. Fourth, obtain all relevant documents from the new client. Be flexible about when and how you deliver the message, but feel free to say one or more of the following to the prospective executive client pressing you for advice during your initial call (most of your would-be clients will appreciate you for it): • “I don’t give advice over the phone to people who are not my clients.” • “You are not my client yet because you haven’t signed a fee agreement.”

The Executive Becomes a Client—The Attorney Begins to Advise

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• “Even if you magically signed a fee agreement and magically deposited the required retainer into the trust account and were a client right now, I can’t possibly answer your questions because I don’t know enough of the facts. The law is what the law is, but the key is understanding how the law applies to your particular facts.” • “What I need from you is a chronology of events setting out everything that has occurred to date [has been negotiated so far] [led up to your termination] and what your goals are. I can either speak with you on the phone and help create the chronology, or you can type up your chronology and send it to me.” • “I also need all relevant documents.” • “Once you sign up as a client and send me your chronology and all relevant documents, I will review everything and get back to you and undoubtedly ask you questions so that I can learn everything I need to know about you and your situation. After I do that, I will be in a position to give you business and legal advice and answer all of your questions and work with you to develop a strategy to address your situation.” § .. the in-person meeting Most lawyers prefer to meet prospective clients in person even though the potential client may not want to take the time to meet them. Practically speaking, executive and entrepreneur clients—especially those who have been referred by a confidant and thus trust you to be a good lawyer before they first speak with you—often do not want to take the time to meet with you. It is true, however, that some clients will not retain you until they are able to size you up face to face. If the would-be executive or entrepreneur client desires an inperson meeting, then obviously you should meet with him.1

§ 5.2 The Fee Agreement and Retainer

Before providing legal advice, you should ensure that your executive or entrepreneur client signs a fee agreement. You should also demand a retainer before committing to represent a new executive or entrepreneur client.2 Asking for a retainer before you begin providing legal services not only ensures your bill will be paid; it often confirms the executive is serious about you and your advice.

1

Some attorneys refuse to represent clients they have never met. If you fall into this category, then you will probably not handle as many executive clients as would want you to represent them. 2 The retainer discussed here is intended to pay for services incurred. It is not a minimum nor earned until services are performed.

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You may lose a few potential clients who will not want to pay the retainer. But most will pay. Sometimes in front-end employment negotiations and less frequently in back-end separation negotiations, executives are able to negotiate for their employers or exemployers to pay their legal bills. But even where they do not or are unable to do so, executives will usually pay a retainer (and their outstanding bills).

§ 5.3 Understanding the Executive’s Situation

Only with a full understanding (or as full an understanding as possible) of the facts important to your executive client’s particular situation can you begin to offer sage business and legal advice. Understanding your executive client’s situation, of course, requires that you be fully aware of his professional life, goals, desires, and dreams. To the extent your client’s personal life plays a part in his professional considerations (e.g., I will never move because . . . .), you must be aware of it as well. Because your executive client presumably wants to give you all you need to best assist him and maximize his personal return, you should be able to learn everything you need to know about your client.3 Understanding what the “other side” (e.g., the employer) wants will probably not be as easy. The other side’s concerns may be unclear, deliberately hidden, or bound up in the employer’s constituent interests. Even in what might appear to be an “easy” or “friendly” negotiation, there is usually some uncertainty because one never really knows everything the employer believes or desires. Yet, understanding the “other side’s” goals, desires, and motivations is critical, just as important as it would be if you were negotiating for widgets, real estate, or oil platforms. If you fail to assess the other side’s “thinking,” the executive risks negotiating a suboptimal result.4 For example, if the soon-to-be CEO is negotiating an employment contract with a public company that just established a strict stock option granting policy after being fined millions for backdating stock options, one of the prospective employer’s goals will almost surely be to follow its new stock option granting policy to a tee.5 It is highly

3

This is not always the case, however. Some executive or entrepreneur clients may be too paranoid or suspicious to divulge everything they should to allow you to best assist them. In addition, some clients may fail to disclose very helpful information, not because they are consciously concealing the information but because, as a cultural matter, they are unfamiliar with disclosing all of their “private” personal and professional concerns to anyone, much less their new and unfamiliar attorney. 4 This is the flip side of the discussion in the introduction to this book. The introduction explains that this book will be valuable to corporate and in-house counsel because it will help them understand the executive’s and entrepreneur’s perspective in employment-related negotiations. On the flip side, as the executive’s and entrepreneur’s counsel, you cannot be maximally effective unless you understand the employer’s perspective in negotiations. 5 The prospective employer’s SEC filings should disclose all SEC investigations and SEC-imposed fines. 17 C.F.R. § 229.103.


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unlikely that that a would-be employer’s compensation committee or board will agree to revise or bend the strict stock option granting policy for the prospective CEO. Realizing this, you would probably advise your executive client to focus on demands within the prospective employer’s stock option granting policy and not expend negotiating capital on requests in conflict with the policy. In most circumstances, the executive’s chronology of events, a review of all relevant documents, and the executive’s due diligence should enable you to quickly assess your client’s situation. § .. the executive’s chronology of events Who, what, when, where, why, how many times, goals, things said, things not said, desires, dreams, expectations, concerns, decision makers. These (and more) are the facts that underpin any advice. Learning everything possible about your executive client’s professional life is a must. A client-prepared chronology of events (stamped “attorney-client privileged”) is an excellent way to learn about the executive’s professional situation.6 The chronology of events should include much more than a chronological listing of events. It should include everything that is important to understanding the client’s situation, including the client’s goals, who the key players are, and an explanation of the impediments the client believes may block what he wants to achieve. When I refer to the client’s “chronology of events” in this book, I am referring to the client-prepared explanation in its broadest sense. Ask the executive to do the following: • Prepare (type up) a chronology of events in his own words explaining the details of his situation. • Set the chronology aside for at least half a day, if possible, before completing it and sending it to you. When the executive rereads his chronology, he will undoubtedly add newly remembered facts and eliminate some facts as unimportant or misremembered. Most people cannot, in one sitting, type up everything they must tell you to allow you to give them the best legal advice. The mind does not work that way. By putting the chronology down for at least half a day, the client allows important facts to “pop” into his head, which he can then add to his chronology. • Prepare the chronology of events on a personal computer, not a work computer. If the client does not own a personal computer, he should prepare the chronology

6

Some practitioners do not like client-provided chronologies of events. Instead, they prefer a detailed interview, followed by a memo to the file. This approach is acceptable although perhaps more time consuming and perhaps more expensive for the client. Regardless of the method of information collection you choose, the key is to learn all critical information about the executive’s professional life.

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on a family member’s personal computer. Doing so prevents an employer from accessing the attorney-client privileged communications in the event something should go wrong. Keep in mind that deleting files from a computer usually does not delete them. Forensic computer experts can exhume significant amounts of “deleted” information from a computer’s hard drive. • Fax, FedEx, or e-mail the chronology of events. Most executives will e-mail you their chronology of events and will take the risk of communicating via the Internet.7 • E-mail from a personal e-mail account via a personal (private) connection to the Internet (e.g., via Comcast, AOL). The executive should not use an employer’s e-mail address nor connect to the Internet via an employer’s Internet connection or Internet service. Avoiding the employer’s e-mail address and Internet connection should ensure that the employer’s systems administrator cannot access the executive’s e-mail correspondence with you. § .. review all relevant documents Carefully review copies of all documents relevant to the executive’s situation, even the boring ones. It seems obvious but bears repeating: You cannot provide quality advice without reviewing all relevant documents. If you fail to review all relevant documents, then you risk giving bad advice. Important clauses affecting the executive are sometimes found in documents where one would not expect to find them. For example, an employer’s CIIAA may contain an arbitration clause requiring the employer and employee to submit all disputes to binding arbitration rather than the judicial system. An unusual clause that “does not belong” in a particular document may be plenty enforceable if the executive signs the agreement. A good place to start when compiling a list of relevant documents is with every agreement the executive signed (or expects to sign) and every document referenced in these agreements. For example, before giving advice on a back-end severance negotiation, the executive should provide copies of his (i) offer letter or employment agreement; (ii) confidential information and invention assignment agreement; (iii) equity agreements (e.g., stock option agreements, restricted stock unit agreements) and the documents governing the equity agreements (e.g., the employer’s equity plan); (iv) bonus and commission plans; (v) long-term incentive plans; (vi) change in control agreement; and (vii) management carve-out agreement. Copies of all relevant e-mails and other documents should also be provided.

7

Using unencrypted email for attorney-client privileged communications carries an added risk of disclosure that should be disclosed to the client. As a practical matter, almost all executives will assume the increased risk of disclosure and communicate with you by unencrypted e-mail. For instructions on how to encrypt e-mail sent with Microsoft Outlook 2007 and higher, see Microsoft Office On-Line, Encrypt Email Messages, http://office.microsoft.com/en-us/outlook/HP012305361033.aspx.


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If a public company is involved in the executive’s negotiation, important documents (e.g., executive employment agreements and executive separation agreements of the senior-most executives) will be publicly available on the Internet for downloading and review. Public companies’ filings are available at www.sec.gov, www.edgar.com, and from Web sites such as Yahoo!8 § .. the executive’s due diligence Companies do not buy other companies without doing significant due diligence. Why, then, would an executive begin a negotiation that will affect him personally—whether for a new job, severance package, or post-acquisition role—without doing his personal due diligence on the players, companies, and constituent interests involved? The answer: He should not. The executive should do as much due diligence as possible on all transactions that affect him. Basic executive due diligence includes a personal investigation, the results of which he should immediately share with you. Section 7.1.4 and § 7.1.5 discuss the executive’s due diligence at greater length.

§ 5.4 Educating the Executive

Do not assume the executive or entrepreneur knows what he should be requesting in his negotiations, nor should you assume he understands his leverage or the best way to obtain what he is looking for. That your client is successful in the business world says nothing about his knowledge of the executive compensation and protection field. If you conclude otherwise, your conclusion may be based on cognitively insufficient information.9 Many times, the executive client will require a tutorial. The lawyer’s job is to give the best possible advice. The executive’s job is to decide on the course of conduct once the lawyer’s advice is received. However, the executive cannot decide what is best for him unless he “hears” (processes) the advice he has been given. Be aware that high-powered successful executives who are on the move and make decision after decision after decision all day long do not always “hear” what you tell them. There are many reasons for this, including that they may have little basis to

8

Public company documents may be accessed via www.yahoo.com by clicking on “finance” on Yahoo’s home page, which brings up http://finance.yahoo.com. From the http://finance.yahoo.com page, type in the ticker symbol of the public company of interest. This will bring up the company’s stock data page. On the left-hand side of the company’s stock data page, click on “SEC Filings.” 9 There is a body of social psychology research on the propensity of individuals to make decisions based on cognitively insufficient information. See, e.g., E. Shafir, Cognitive Psychology of Decision Biases, in International Encyclopedia of the Social & Behavioral Sciences, at 3296–3300 (Neil J. Smelser & Paul B. Baltes, eds., Elsevier 2001).

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appreciate what you are saying. You cannot guarantee your executive client will “hear” you. But you can try. If you suspect your client might not “hear” you, send him your concerns in writing. If you believe he has chosen a potentially detrimental course without “hearing” you out, tell him bluntly: “I do not agree with you and I am going to send you a cover-yourass letter to lay out my concerns.”10 A surprising number of nobody-tells-me-how-torun-my-company executives begin focusing when they receive a direct e-mail or letter that states, on its face, that their attorney is cya’ing himself.

§ 5.5 Representing Rocket Scientists and Professional Negotiators

You may be an Ivy League valedictorian; the star of your Stanford, Yale, Harvard, or Michigan law school class; a former Supreme Court Clerk; and a member of the Mensa Society, but if you represent executives and entrepreneurs long enough, at some point, you will wind up with a rocket scientist client who is just plain smarter than you. He will know it. And you will know it. When this happens, you should handle the situation in a way that ensures that your rocket scientist client trusts your less-able mind to impart all the information he does not have, but very much needs, to negotiate whatever it is he wants to negotiate. First and foremost, be yourself and be confident. You know the ground rules, the law, and the world of executive deal making. Your rocket scientist client is on your playing field, not the other way around. Your job is still to provide the best advice you can. And your client’s job—rocket scientist or not—remains the same: to decide what to do about your sage advice. With rocket scientist clients, you must be prepared to think outside the box, not because your advice may be new or different, but because the super-brilliant client may not “hear” your advice unless you deliver it in an unusual way. Brilliance is wonderful, but the brilliant do much better when well coached. One of Princeton’s legendary basketball coaches wrote a book, The Smart Take From the Strong.11 And his teams regularly did because they were well coached. If you practice long enough, you will also undoubtedly wind up representing professional negotiators of one type or another; individuals who have negotiated deals between countries, between sports franchises, or between high-profile multinationals; people

10

“Cover your ass” and “cover my ass” are not “professional” phrases. Nevertheless, executive and entrepreneurs from coast to coast understand exactly what the attorney is saying when he declares he is writing a “cover-your-ass” or “cover-my-ass” letter or e-mail. In the way that a picture is sometimes worth a thousand words, delivered at the proper time for an appropriate purpose, the phrases, “I am sending you this e-mail to cover my ass,” or “This is the cya letter I said I would send you,” will often gain the executive’s or entrepreneur’s attention in the way thousands of explanatory words would not. 11 Peter Carril with Dan White, The Smart Take From the Strong: The Basketball Philosophy of Peter Carril (Simon & Schuster 1997).


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who hang out with ambassadors and other players and seem to know everyone in both the business and political world and every negotiating tactic known to man. You, the professional negotiator, will be representing the professional negotiator client. In many ways, the professional negotiator client may be as needy (and as difficult) as your worst client. He may drive you nuts with his questions, phone calls, and e-mails. On the other hand, for you, the professional negotiator, representing another professional negotiator may turn out to be a pleasure, even a learning experience. Three points to keep in mind when representing rocket scientists and professional negotiators (and other difficult clients): • The rocket scientist and professional negotiator client may need more assistance than the “typical” executive client because he may be too close to his negotiation. The adage “a lawyer who represents himself has a fool for a client” goes double for a rocket scientist or professional negotiator who negotiates a complex personal deal for himself, thinking no one can possibly do better than he can. • There is nothing wrong with firing a client.12 Firing the excessively difficult client, like bypassing a potential client who you think may not pay his bills, is a cost of doing business. If you are good at what you do, there will always be another client. • If you are billing by the hour, the more of your time the rocket scientist or professional negotiator eats up, the more you earn. The professional negotiator and rocket scientist client’s questions, insights, and thoughts are the product of an active mind, which is probably what makes him great at what he does. If the questions, insights, and thoughts become too much, feel free to remind him you are happy to help him, but he will pay for every minute of your time. Straightforward talk sometimes has a salutary effect on those who know, at some level, they are asking questions that they really do not need answered.13

12

Providing, of course, that when you fire your client you are not running afoul of the rules of professional conduct in your jurisdiction. 13 Although they may not be rocket scientists or world-class negotiators, attorneys (e.g., general counsels, assistant general counsels) may also be very difficult clients.

6 GE N ERA L NE G OT I ATION CON S IDE RATION S F O R E X E C UTI V E S

§ 6.1 The Principals Should Negotiate Directly—Most of the Time

Many freshly fired senior executives will instruct you, “Call them and demand . . . .” Visceral, commanding directions are understandable when they come from a newly unemployed, invariably wounded (on some level, at least) executive who dearly desires to distance himself from the recent unhappiness and perhaps reassert a modicum of control over his life. Nobody enjoys getting punched in the face. However, while it may be natural and understandable for the freshly fired executive to want you to negotiate his exit package, the executive who removes himself as negotiator may be hurting, rather than helping, his cause. Even in the friendliest of negotiations, for example when both prospective employer and executive enter negotiations expecting the executive to be the company’s next CEO, your client will often ask, “should you negotiate for me?” The decision whether you or your executive client, or perhaps someone else, should negotiate on behalf of the executive is a judgment call. The decision should be made coldly and calculatingly, on a case-by-case basis, after all competing dynamics have been assessed. The ultimate goal: to choose the negotiator and negotiation strategy that maximizes the executive’s chances of receiving what he wants from the negotiation. Keep in mind that what the executive wants from a negotiation may be a complex set of considerations, many of which may be at cross-purposes with maximizing short-term financial gain.

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General Negotiation Considerations for Executives

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About 80 to 90 percent of the time, the executive is better off negotiating the key business terms of his deal, with you acting as shadow counsel.1 While your direct involvement will almost certainly be required at some point in the life cycle of the executive-driven negotiation (e.g., when the parties reach the point where it is appropriate to discuss specific contract language), often the negotiation will be smoother and results superior when this happens after the parties have agreed on the details of the business arrangement. This is not to say that you, as sage attorney and business advisor, are destined to provide second-best results for your executive client if you handle the negotiations from beginning to end. It is simply to say that principals (for example, a board member and a CEO or ex-CEO) negotiating a face-to-face deal are more likely to move further and faster in their negotiations if their initial discussions exclude attorneys, even in situations where the principals dislike each other. Once lawyers become directly involved in an executive negotiation, negotiations may slow down, and the other side may shift away from the let’s-do-a-business-deal mindset to the let-the-lawyers-fight-it-out approach. Furthermore, many lawyers— very possibly the other side’s attorney—have few negotiating skills; are excessively adversarial; and tend to retard, rather than facilitate, deal making. Thus, the freshly fired chief operating officer often optimizes his chances of expeditiously achieving his desired goals (for example, the competing goals of obtaining significant separation pay without burning professional bridges) by calendaring a 1:1 to discuss severance with the CEO who just fired him for incompetence. Not always, but often. Most assuredly, your executive client’s negotiation should not take place without your involvement. Just the opposite: you should be intimately involved as shadow counsel. In fact, the executive who trusts you to give superb legal and business advice may call you repeatedly (and unfortunately, at all hours!) to bounce negotiating ideas off of you. Ten to 20 percent of the time, you, as a savvy negotiator, will be able to negotiate a better deal for your executive client than he would be able to negotiate for himself.2 If you represent executives and entrepreneurs long enough, you will invariably be involved in tough negotiations where the attorneys achieve a win-win result for all, despite their clients’ best efforts at scuttling the transaction. Certain situations, such as complex multiparty merger negotiations, may require immediate attorney involvement to advance the negotiations. In other circumstances, dysfunctionality (not just dislike) in the principal-principal relationship may require immediate and direct attorney input.

1

The 80–90 percent figure is an anecdotal figure of speech used to emphasize a point. It is not derived from a survey or study. 2 Again, the 10–20 percent figure is intended as a figure of speech. It is not derived from a survey or study.

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§ 6.2 Negotiations Should Be Face to Face

They-should-know-better executives will often tell you that they will send an e-mail to the other side with their demands. Your response should almost always be: “Do not do that.” E-mail may be easier for the executive than presenting his demands in person, but it has the greatest chance of achieving suboptimal results. Choice number one: negotiate face to face. A poor second choice: negotiate by telephone. An even poorer third choice: negotiate via e-mail.3 It is more difficult for a person to say “no” when the request is made face to face than otherwise. For this reason, professional fundraisers know the personal “ask” is the most effective approach. Consequently, there are times when you should advise your executive client to fly across the country to personally visit with the relevant board member or management team member to make his “ask.” That the CEO of a company with whom your executive client is negotiating a new employment agreement lacks a particular provision in his employment contract does not mean your client should eschew asking for the provision. When faced with the CEO’s invariable, “I don’t even have that clause in my employment contract,” the quick-on-his-feet executive meeting face to face with his prospective boss might respond, “You should have hired my attorney.” Sometimes, sought-after management team additions who have developed a good rapport in face-to-face discussions with their would-be managers are successful in negotiating for terms missing from the employment agreements of the prospective employer’s senior management team.4

3

Research supports the face-to-face approach. See, e.g., Charles E. Naguin, Terri R. Kurtzberg & Liuba Y. Belkin, Email Communication and Group Cooperation in Mixed Motive Contexts, 21(4) Soc. Just. Res. 470 (Dec. 2008) (respondents using e-mail were less cooperative than respondents communicating face to face); Allyson L. Holbrook, Melanie C. Green & Jon A. Krosnick, Telephone Versus Face-to-Face Interviewing of National Probability Samples with Long Questionnaires: Comparisons of Respondent Satisfaction and Social Desirability Response Bias, 67(1) Pub. Opinion Q. 79 (Spring 2003) (“People are less competitive, less contradicting, more empathetic and interested in their partners’ perspectives, and more generous to one another when interactions occur face-to-face instead of by telephone” [citations omitted]; people are more honest as the “social distance” between them decreases; response rates for face-to-face interviews were 10 percent higher than for telephone interviews); Aimee L. Drolet & Michael W. Morris, Rapport in Conflict Resolution: Accounting for How Face-to-Face Contact Fosters Mutual Cooperation in Mixed-Motive Conflicts, 36 J. Exper. Soc. Psych. 26 (2000) (nonverbal expressive behavior in interactions builds a state of mutual positivity and interest, termed rapport, which is higher in face-to-face interaction than by telephone; telephone found to build more rapport than e-mail or written text); Lawrence A. Jordan, Alfred C. Marcus & Leo G. Reeder, Response Styles in Telephone and Household Interviewing: A Field Experiment, 44 Pub. Opinion Q. 210 (Summer 1980) (asked for their total family income, 12 percent of face-to-face interviewees refused to answer, while 21 percent of telephone interviewees refused to answer). 4 The prospective employer’s negotiator acceding to the prospective executive’s requests may be doing so because he wants the same terms included in his agreement and plans to use the prospective executive’s contract as leverage to negotiate better terms for himself.


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Not all executives, especially in back-end severance negotiations, feel comfortable, or even able, to negotiate face to face. For these clients, preparation is a must. Preparation takes different forms for different people. Some executives feel more comfortable after memorizing the bullet points of their upcoming negotiation. Others must “practice” the discussion, sometimes talking into a mirror for hours on end. Still others practice by asking you how they should respond to multiple “if-then” scenarios. Employers know about the personal “ask.” This is one reason why, during severance negotiations, employers may go to great lengths to interpose a human resource professional between the employer’s decision maker and the departed (or departing) executive. Rarely do HR professionals make decisions. They exist to deflect, to wear down the executive, to bear the bad news that the company has no room to negotiate, and to lie as required. Most HR professionals will protect the employer at all costs. The executive should do his best to avoid the employer’s HR professional and negotiate with the appropriate decision maker.

§ 6.3 The Employer May Control the Documents

The employer will almost always want to control the first draft of contracting documents. In other words, as the executive’s attorney, you usually achieve little by sending the first draft of an employment agreement, separation agreement, or other contract to the company or its counsel. Let the employer and its counsel control the first draft. The employer and its attorneys intimidate with their first drafts only if you and your client allow yourselves to be intimidated. That an employer controls the first draft of a contract does not mean the executive must agree to any of the terms it contains. A redlined turn of the documents will usually readjust the negotiating playing field.

§ 6.4 The Executive’s Attorney in the Negotiation

§ .. the attorney as shadow counsel Executives negotiating employment agreements (and sometimes those negotiating severance packages) often ask whether they should tell their prospective employers that they have counsel. These executives worry that prospective employers will not hire them if the companies know they have a lawyer. At the most senior levels, however, a prospective employer’s board of directors might look askance at a would-be senior hire without an attorney. How shrewd will the board believe an executive is if he does not have counsel? And the board surely wants to hire a shrewd executive because once the employment contract is completed, the employer will be the beneficiary of the executive’s shrewdness.

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The executive is shrewd, in part, because he has retained you. In turn, your behind-the-scenes guidance may key the executive’s negotiating success. For example, the executive preparing to discuss “what he wants” with his prospective employer or its recruiter will be properly prepared for the discussion after you have told him all that he should consider requesting. As another example, the recently fired, angry executive may need to hear the following from you before he is mentally prepared to negotiate: • “You, not I, are the best person to negotiate your deal, no matter how much you hate Mr. CEO who just fired you. Call Mr. CEO and ask him for a meeting.” • “Your goal is to maximize your personal return. Remove the emotion from your negotiation as much as possible. Decide coldly and calculatingly the best way to achieve your goals.” • “Treat yourself as a widget when you are negotiating. Here, the widget is the value of your labor. The only difference between your severance negotiation and any other negotiation is that you are now negotiating the value of your labor.” • “Keep perspective. If Mr. CEO wants to hear a mea culpa, who cares, as long as the mea culpa is private? If you’re going to get more for your personal widget as a result, close the door, tell your ex-boss whatever will make him happy, and take the gain all the way to the bank.” • “What is it you really want from this negotiation?” § .. the attorney as late-stage negotiator In straightforward employment contract or employment severance negotiations, counsel should often wait to become directly involved until the business deal is complete, and the parties have progressed to discussing legalese, such as the definitions of “Cause” and “Good Reason.” While the negotiation of the legalese may require business decision making and take longer to negotiate than the key business terms of the deal, the legalese negotiation is the back half of the transaction. By the time the parties focus on legalese, they expect to complete the deal. § .. the attorney as negotiating scapegoat One of your key roles negotiating for (or advising) your executive client may be to play scapegoat. There are two general categories of attorney scapegoatism. In category one scapegoatism, the attorney scapegoat takes the blame for negotiating “too hard” for his executive client, and by doing so, facilitates the principal’s smooth negotiation. In category two scapegoatism, the attorney scapegoat takes the blame for intransigently insisting that a term must be included in the contract and by so doing, either facilitates or tanks the deal.


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Your job as type one scapegoat will often be to float trial negotiating balloons that may be shot down by the other side without your executive client losing face. When this happens, your client will blame you, his attorney, for the hideous proposal and, thereafter, move on to the next negotiating topic. Sometimes attorneys are pure straw men, battling out the terms of a deal—at the specific instructions of their principals— while the soon-to-be-CEO and the prospective employer’s chairman of the board enjoy a quiet conversation together. Everyone knows what is going on while you, as executive’s counsel, become a bigger and bigger scapegoat as the negotiation progresses. The parties understand that you are floating trial balloons because your executive wants you to do so. However, as a psychological matter, and ultimately a business one, it is often easier for the principals on both sides to move seamlessly forward in their negotiations while “blaming” you for negotiating “too hard.” The dynamic is different for a category two attorney scapegoat. When the other side pushes for a result that your experience tells you is very bad for your executive client— or worse, illegal—you must intercede as a bulwark. If the request is an illegal one, obviously you must instruct your executive to say “no.” On the other hand, if the request is simply diabolically bad as a business matter, you must intransigently insist to the other side that the request is unacceptable and must be withdrawn. You should assent to the request only after (i) ensuring (in writing if possible) your executive client understands all the downsides and (ii) the executive specifically instructs you (in writing if possible) to concede. When the other side insists on atrociously bad terms, consider advising your executive client to tell the business person with whom he is negotiating that he can blame whatever position you have insisted the executive take on you. To strengthen this message, you might advise your executive client to tell the other side to have its attorney call you. This type of “blame-the-attorney” scapegoatism is sometimes necessary to ensure deal points that must be included in a deal are, in fact, included. § .. be flexible To best advise executives and entrepreneurs, you must be flexible, ready for the unusual, and willing to think outside the box. Executives and entrepreneurs are often at the cutting edge, and their problems, and the solutions to those problems, may require a creative approach.

7 PR E - E MP LOY M E N T: N E GOTIATIN G THE E M P LOY ME N T CO N T RAC T A N D R E L ATE D AGRE E M E N TS

§ 7.1 The Executive and His Goals

§ .. what does the executive want? Equity, base salary, bonuses, commissions, long-term incentive plans, benefits, perks, severance, accelerated vesting, extended post-termination exercise periods, and much more are all potentially important parts of an executive’s employment contract. It may seem basic, but it is important to understand before the negotiation begins which of these (and other) considerations are most important to the executive. As a first step, ask your executive client: “what do you want out of this negotiation?” In many cases, you should ask that he include his list of desires as part of his chronology of events (key players, communications to date, etc.).

§ .. the importance of protection Although the executive may not know it, he is often better off in a negotiation by trading away a little salary or equity in exchange for more protection for the equity he receives. This is because executives are fired all the time. And they are fired for myriad reasons, including economically irrational ones. Negotiating for stock options for five percent of an employer’s fully diluted equity means little if the executive is fired before the stock vests. For many successful executives, their firing comes as a shock. Frequently, it is the first time the executive has been fired; the first time he has been mistreated at work; 62

Pre-Employment: Negotiating the Employment Contract and Related Agreements

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and, in the case of economically irrational employment terminations, the first time his A+ performance did not matter. A protected executive can tell the firing employer: “Your decision to fire me is foolish. But if you want me to go, simply pay me severance and accelerate my equity vesting as required by my employment agreement.” By contrast, the unprotected or inadequately protected executive must do his best to negotiate a severance agreement during the departure process or after the termination of his employment. § .. the employment agreement as guaranteed severance The employment agreement (or well-negotiated offer letter) in most at-will employment situations is little more than a severance contract negotiated before the first day of employment. Severance agreements masquerading as employment contracts are negotiated all the time. If your executive client believes otherwise or believes discussing severance before employment begins sends the wrong signal, you are there to educate him. § .. the executive’s due diligence on the prospective employer The executive should do as thorough an investigation as possible on those he will be working with before he accepts employment with a prospective employer. The investigation, of course, requires that he keep his eyes and ears wide open during the employer’s interview process. The executive may be able to learn significant facts directly or by “reading between the lines.” During the interview process, however, prospective employers may not advertise the shortcomings of their company, products, or management team. If possible, as part of his personal due diligence, the executive should contact those who have most recently left the employer, especially former subordinates of the manager to whom the executive will report. By doing so, the executive may be able to uncover the “true story” (presuming there is another “story”) about the prospective employer and its inner workings. What is important about the executive’s due diligence is collecting as much information as possible about the would-be employer and its constituent interests. At the end of the day, the executive may hear very bad things about his prospective manager, executive team, or employer, yet nonetheless decide to accept the job offer. If the executive does so, however, he will begin work knowing the risks. § .. the public company’s public documents Due diligence on a prospective public company employer must include an investigation of its public filings. Many public companies routinely offer equity or salary protection (severance) to new senior executive hires, information that should be readily verifiable in the company’s SEC filings. Public companies are those whose stock trades on the public securities markets such as the New York Stock Exchange or NASDAQ. Thousands of companies of all sizes and financial conditions are publicly traded in the

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United States. General Electric, Google, Illinois Tool Works, Yahoo, Hewlett Packard, JPMorgan Chase, Apple, and Vail Mountain Resorts are some examples. The stock of a foreign parent company of a United States subsidiary (and employer) may trade on a foreign stock market, such as the London Stock Exchange or the Frankfurt Stock Exchange. For example, German multinational Siemens AG trades as SIE on the Frankfurt Stock Exchange. Some of these foreign traded entities also trade American Depositary Receipts (ADRs) on the New York Stock Exchange.1 Siemens AG ADRs trade under the ticker symbol SI on the New York Stock Exchange. United States public companies are usually subject to the reporting requirements of the United States Securities Exchange Act of 19342 and the SEC’s rules and regulations.3 All public companies subject to the reporting requirements of the Securities Exchange Act of 1934 are required to disclose the compensation packages of their directors and Named Executive Officers (NEOs).4 A company’s NEOs are its CEO, CFO, three highest paid executives other than the CEO and CFO, and up to two additional non-executives who are paid at least as well as one of these five executives.5 A public company’s annual proxy statement lists the compensation of the employer’s directors and NEOs. In addition, the proxy statement includes a section labeled, “Compensation, Discussion and Analysis,” or “CD&A” for short. In the CD&A, the company is required to explain all material elements of its executive compensation programs.6 Broader disclosure regarding executive compensation will soon be required. Dodd-Frank requires the SEC to pass a number of disclosure-related regulations, including rules obligating public employers to provide “a clear description” of NEOs’ compensation in their proxy materials, including the relationship of executive compensation to “the financial performance of the [employer], taking into account any

1

The SEC explains ADRs as follows: The stocks of most foreign companies that trade in the U.S. markets are traded as American Depositary Receips . . . . U.S. depositary banks issue these stocks. Each ADR represents one or more shares of foreign stock or a fraction of a share. If [one] own[s] an ADR, [he has] the right to obtain the foreign stock it represents, but U.S. investors usually find it more convenient to own the ADR. The price of an ADR corresponds to the price of the foreign stock in its home market, adjusted to the ratio of the ADRs to foreign company shares.

Securities & Exchange Commission, American Depositary Receipts, www.sec.gov/answers/adrs.htm (last modified Jan. 31, 2007). 2 15 U.S.C. §§ 78a, et seq. 3 See About the SEC, www.sec.gov/about.shtml, for a list of applicable rules and regulations. 4 SEC Regulation S-K, Item 402, 17 C.F.R. § 229.402. In late 2009, the SEC issued a final rule, “Proxy Disclosure Enhancements,” which requires public employers to expand their disclosure regarding executive compensation. The final rule amended 17 C.F.R. Parts 229, 239, 240, 249, and 274. 5 17 C.F.R. § 229.402(a)(2)–(3). 6 17 C.F.R. § 229.402(b).


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change in the value of the shares of stock and dividends of the [employer] and any distributions.”7 Dodd-Frank also requires the SEC to establish rules prohibiting national securities exchanges and associations from selling the stock of a public company unless the company discloses its policies for bonuses, commissions, and other incentives in situations where the incentive compensation is based on financial information the company must report to the SEC.8 When these SEC rules become final, bonuses based on a public employer’s gross revenue or earnings per share, for example, must be disclosed, whereas bonuses based on non-financial milestones (e.g., hiring a sales team) may not need to be reported.9 Public companies are required to disclose all key executive employment-related agreements such as employment agreements, severance agreements, stock option agreements, change in control agreements, and indemnification agreements.10 Public

7

§ 953 (Securities Exchange Act of 1934 § 14(i)). The SEC plans to issue implementing rules in August– December 2011. SEC, Implementing Dodd-Frank Wall Street Reform and Consumer Protection Act – Upcoming Activity, www.sec.gov/spotlight/dodd-frank/dfactivity-upcoming.shtml (last visited Mar. 1, 2011). 8 Dodd-Frank § 954 (Securities Exchange Act of 1934 § 10D(b)(1)). The SEC plans to establish implementing rules in August–December 2011. SEC, Implementing Dodd-Frank Wall Street Reform and Consumer Protection Act – Upcoming Activity, www.sec.gov/spotlight/dodd-frank/dfactivity-upcoming.shtml (last visited Mar. 1, 2011). 9 Dodd-Frank also requires the SEC to require public companies to disclose: (1) “the median of the annual total compensation of all employees of the [employer], except the [CEO]”; (2) “the annual total compensation of the [CEO];” and (3) the ratio of (1) to (2). § 953 (amending 17 C.F.R. § 229.402). § 955 of Dodd-Frank obligates the SEC to establish rules requiring public employers to disclose whether any employee or member of the board of directors or any of their designees are permitted to purchase financial instruments (e.g., puts, calls, collars) designed to hedge their employer’s stock or other equities (e.g., stock options). (Securities Exchange Act of 1934 § 14(j)). Dodd-Frank compels federal regulators to establish rules requiring certain banks, FDIC depositories, registered broker-dealers, credit unions, and investment advisors with assets of $1 billion or more to disclose to “the appropriate federal regulator” their incentive-based compensation structures so that the regulator may determine whether “an executive officer, employee, director, or principal shareholder” will receive “excessive compensation, fees, or benefits,” or the incentive-based compensation “could lead to material financial loss to the covered financial institution.” § 956(a)(1), (f). Federal regulators are required to write regulations to prohibit payment arrangements that encourage inappropriate risks because of “excessive compensation, fees, or benefits” or that “could lead to material financial loss.” § 956(b). § 956 does not obligate an affected employer to report the compensation of particular individuals. § 956(a)(2). § 956 is enforceable via § 505 of the Gramm-Leach-Bliley Act., § 505, Pub. L. 106-102, 113 Stat. 1338 (1999). The SEC plans to issue implementing rules in April–July 2011. SEC, Implementing Dodd-Frank Wall Street Reform and Consumer Protection Act–Upcoming Activity, www.sec.gov/ spotlight/dodd-frank/dfactivity-upcoming.shtml (last visited Mar. 1, 2011). These regulations will expand on the “Guidance on Sound Incentive Policies” for banks issued jointly by the Office of the Comptroller of the Currency (Treasury Department), Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision (Treasury Department) in June 2010. 75 Fed. Reg. 36,395 (June 25, 2010). The Guidance “address[es] the safety and soundness risks of incentive compensation practices by focusing on the basic problem they can pose from a risk-management perspective” and was issued as a regulation implementing Section 8 of the Federal Deposit Insurance Act. 75 Fed. Reg. 36, 398; 12 U.S.C. § 1818. 10 See 17 C.F.R. Parts 229, 239, 240, 249, and 274.

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companies may also have ERISA-based retirement or severance plans that must be publicly disclosed. In addition to the compensation-related information they contain, public company filings also include considerable financial information and other disclosures (e.g., disclosures regarding competitors) about the potential employer that may be useful as the executive considers joining the company. Public company filings and documents are available online at www.sec.gov or www. edgar.com. The information can also be accessed via Yahoo! and other Web sites.11

§ 7.2 Avoiding Equity Pitfalls in Private Companies

§ .. what percentage of the company does the equity represent? You will be amazed at the number of executives who insist they negotiated (before they called you) an excellent deal because their prospective private employer offered them an option to purchase 600,000 shares, or 1 million shares, or many millions of shares of the company’s common stock. However, a stock option for a gross number of shares of a private company’s stock means absolutely nothing. What matters is the percentage of the equity of the fully diluted capital on an as converted to common stock basis of the employer that the gross number of shares subject to the option represent.12 A stock option to purchase 1,000 shares of a private employer’s common stock may be much more valuable than a stock option to purchase 1,000,000 shares of another private employer’s common stock. If the first employer has 2,000 shares of stock issued and outstanding, then the option for 1,000 shares represents an option to purchase 50 percent of the first employer’s equity. On the other hand, an option to purchase 1,000,000 shares of a second employer that has 100,000,000 shares issued and outstanding is an option to purchase only 1 percent of the second employer’s equity. The prospective private employer’s capitalization table (“cap table” for short) will detail the company’s capital structure, giving the executive the information he requires to understand the “value” of the proposed equity grant.13 The executive should ask for the cap table at the outset of the negotiations. If a would-be private employer prefers not to produce its cap table during negotiations, then the employment agreement should contain an employer’s representation along the following lines: “The [number] shares subject to the Executive’s employee stock option is equal to [ ___ ]% of the fully diluted capital of the Company on an as converted to common stock basis including, without limitation, all common stock, all preferred stock, all stock reserved for issuance under the Company’s equity plan, all options, all

11

See Chapter 5, footnote 8. See § 4.19.1 for an explanation of preferred stock and financing rounds. 13 The equity structure of public employers is publicly available. 12


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warrants, and all convertible equity.” If the employer’s representation is incorrect, it may be liable for common law fraud and securities fraud.14 § .. what is the overhang? liquidation and other preferences Understanding the prospective employer’s capital structure is critical, but it is only one part of the puzzle that the executive must learn before concluding negotiations with a private employer. If the prospective employer is private, particularly if venture capital or private equity financed, it is equally critical to understand the preferences held by the employer’s preferred stockholders. One thousand shares of common stock of a would-be employer may represent 50 percent of the fully diluted capital of the company, but at the same time, may not represent much value to the executive if the other 50 percent of the company’s stock is preferred stock carrying significant liquidation preferences. The liquidation preferences of the preferred stockholders of an employer determine the amount of money from the sales price of a company that must be paid to the preferred stockholders (investors) before any part of the sales price of the company is paid to the shareholders of the company’s common stock. The size of the liquidation preference is sometimes referred to as the “overhang.” Management usually owns common stock or options to purchase common stock. The rights and preferences, including the liquidation preference of management’s common stock, are usually inferior to the rights and preferences of the preferred stock. This means that in certain company transactions, the preferred stockholders, because of the superior liquidation preferences attached to their stock, will receive 100 percent of the value of the transaction, while management and the other company’s common stockholders receive nothing. For example, an employer with $100 million in investor financing and preferred stock with a 2x liquidation preference (meaning the investors receive a return of twice their investment on the sale of a company before the common stockholders earn anything from the sale) must be sold for more than $200 million (the overhang) for the common stockholders to receive anything from the sale. In this example, the first $200 million of the employer’s sales price will be paid to the preferred stockholders. The rights and preferences of most private companies’ common and preferred stock should be publicly available.15 The Certificates of Incorporation of all Delaware companies, for example, are publicly available and will disclose the rights and preferences of the Delaware companies’ preferred stock.16

14

See, e.g., 15 U.S.C. §§ 78t-1, et seq. Executives planning to join a public company should not be concerned with the type of overhangs described in this section, although they should understand the company’s equity structure, which will be publicly disclosed and easily ascertainable from the prospective employer’s public filings. 16 See Chapter 4 footnote 20 for additional information. 15

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Executive Story Munir, a successful chief technology officer, who is known for giving astute advice to others, was offered a “great” job at a private company that had received more than $100 million in venture capital funding. Munir assured me the prospective employer was bringing him in to re-jigger the company’s products and ready it for an IPO or sale. To Munir, everything about the company “looked like a go.” The company’s revenue had increased for many consecutive quarters. It had a strong management team. It had excellent products. Munir also would receive enough options to make him very rich if the prospective employer were to go public. The huge potential problem: the company’s liquidation preferences. For all his experience, Munir did not know anything about liquidation preferences and did not understand how they might affect him. I realized this and diligently attempted to educate Munir about them. I spoke at length with Munir about the preferences and how they might impact his personal bottom line. I wrote him detailed e-mails laying out all the risks of working for an employer with a significant overhang. I insisted that Munir review the company’s financing documents. I suggested that Munir ask his prospective boss, the company’s CEO, for a management carve-out agreement as a way to address the risks caused by the company’s liquidation preferences. Eventually, Munir told me he understood everything, decided not to request a management carve-out agreement, signed his employment contract (which we had negotiated and which contained a host of protective clauses, including single trigger accelerated vesting and severance on termination of employment without Cause by the company or by Munir for Good Reason), and went to work for the company. A few years later, Munir’s employer experienced a “hiccup.” The once high-flying company planned to sell itself for an amount roughly equal to its liquidation preferences. Munir called to tell me that he finally understood what it meant to have a huge overhang. For all his hard work in positioning the company for success, Munir was not going to receive anything from the deal because the investors were slated to take the entire sales price for themselves. Munir said, “You know, I read everything you wrote me a few years ago, and I just reread the emails now, and I have to admit that I really didn’t appreciate what you were telling me about the liquidation preferences. This stuff is really important.”

§ 7.3 Telling the Executive What He Needs to Hear

§ .. ensuring the executive thinks through all the issues Before retaining you, the repeat public company CEO may have considered all the important issues likely to arise in his employment negotiation. So, too, the repeat executive client who learned everything from you during his previous negotiations.


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Most often, however, the executive, especially the first-time client, has not thought through all the issues because he does not know all the issues to consider. This is true even if the executive is a millionaire many times over. The multimillionaire may never before have negotiated an employment agreement. Or he may have retained inexperienced counsel the last time and done exceedingly well despite, not because of, his counsel. Your goal: To educate, to guide, and to advise. You should teach your executive client everything he may want from his upcoming employment negotiation so that the executive can determine what he desires from the negotiation and the priority of his desires. Start with the executive’s response to your query, “What do you want out of this negotiation?” and build from there. In addition to imparting information prenegotiation, you should also help your client lay out his decision tree. By giving serious thought ahead of the negotiations to decisions he may make once his negotiations begin, the executive should be better able to focus on the issues most important to him, better able to determine his bottom line, and better able to decide when to walk to the door. The decision tree is an “if-then” decision-making model for possible offers, responses, and results in the upcoming negotiation. To begin creating an if-then model, fill out x, y, a, b, c, and d in the following sentences with all possible negotiation permutations: • If would-be employer offers x, then executive will respond with y. • If prospective employer offers a and b, then executive will respond with c and d. Executive Story Grady has an M.D. from one of the world’s top universities and was on the executive management team at a successful public company. While Grady can talk medicine with the best of doctors, he also excels as a businessman because he has an intuitive understanding of negotiation dynamics. Grady had worked himself up through the corporate ranks, and by the time he first called me had cashed out millions of dollars in stock options. Yet, Grady had never signed an employment contract. One day, a recruiter called Grady about joining a high-flying biotech company. The position offered a big upside, but Grady would leave millions in unvested stock options on the table at his current employer. When he called me, Grady explained that he is a big name in his particular field and would thus have negotiating leverage with the prospective employer. Grady told me he wanted to know everything he should ask for in an employment negotiation. Grady assured me that his current employer would counter any employment offer because he knew all that there was to know about the employer’s product. He told me his current employer could not afford to lose him because it had just changed CEOs, and the new CEO was an external hire—Grady had been passed over for the top job.

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“Based on what you just told me,” I began, “I think there is a good chance that the new CEO will reorganize you out of the company because he will want to get rid of all threats, and you are a threat. If this happens, think about negotiating an exit package, while at the same time negotiating an employment agreement with the new company. Your goal would be to sign the severance agreement on Friday and your new deal with your new employer the following Monday.” “It will never happen,” Grady assured me, “because I know more than anyone about the company’s business.” I dropped the topic. A few weeks later, while still doing the dance with his prospective new employer, Grady sheepishly called to let me know his CEO had just announced a big reorganization and left him well down the organization chart. Grady had never been demoted in his life and had no idea what to do. I urged Grady to meet with the new CEO and begin the conversation with, “I’ve done a tremendous job for this company, but I know you don’t want me here anymore. That’s OK. Just pay me the severance I deserve, and I’ll move on.” A few days later, Grady reported back that the CEO had been exceptionally courteous and was very receptive to a separation agreement. Over the next week or so, Grady negotiated a healthy exit package. At the same time, the prospective employer decided it absolutely needed Grady. Of course, it had no idea that Grady was also negotiating a severance agreement with his current employer. Because Grady had leverage, he was able to push and push and push the prospective employer. When Grady chortled at a suggestion from me, “That’s a great idea. I’m going to ask them for it,” it was like listening to an overjoyed child who has just won an arcade game. As it turned out, the prospective employer repeatedly conceded to many of Grady’s demands because he was a high-profile win for it. Grady signed his separation agreement and, shortly thereafter, signed an employment agreement with the new employer.

§ .. the market — equity ranges The percentage of the employer’s equity that an executive can legitimately demand as compensation in employment negotiations depends on many factors, including the executive’s position, the executive’s leverage, the prospective employer’s business, the stage of development of the company, the would-be employer’s location, the presence of outside investors, the prospective employer’s likelihood of success, expected dilution after future financings, the company’s desire to hire the particular executive, and so forth. For example, a first-time executive joining an early stage start-up might command an option to acquire between 3 percent and 20 percent of the fully diluted capital of the prospective employer over a four-year period. But the same executive


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hired to run a successful, cash-flow-positive company before a pre-IPO financing round may only receive an option to purchase between 1 percent and 7 percent of the fully diluted capital over the same period. Consequently, to be in a position to negotiate for the best possible equity agreement for the executive, it is critically important to understand, and make sure your client understands, before negotiations begin, the dynamics of the equity compensation market affecting your client. § .. the letter to the executive client When your executive client sends you his hot-off-the-presses offer letter or employment agreement, he will invariably want your thoughts as soon as possible. Slow him down. Do not trust your executive client to remember your detailed advice about his job offer, nor should you trust that he will absorb the import of your recommendations. Furthermore, while your client will listen to you, he probably will not “hear” what you tell him in the way you tell it to him. Write your client a letter or e-mail with a detailed analysis of his offer letter or employment agreement and with specific recommendations. Do not be cowed by the executive who wants to negotiate his employment package yesterday. You help your executive client when you write the letter because he will receive full information in writing and will be able to study your analysis as many times as needed for his personal decision-making process. The analytical letter also helps you because you will be certain you have done your job. Moreover, if your advice is sound and in writing, most executives will not “blame” you if they ignore your advice to their detriment. Shrewd clients know when they receive good advice. Over and over again, your executive clients will thank you for your comprehensive analysis and recommendations, even if they must wait to receive your advice. Some will thank you for the analysis and explain they are taking all the risks you warned them against but few, if any, will complain about the extra attorneys’ fees the letter cost. An example of an analytical letter is included in this chapter’s appendix.

§ 7.4 Anatomy of an Employment Agreement/Offer Letter

This section describes the most common clauses in an executive employment agreement or offer letter. Not all of these clauses will be contained in every employment agreement or offer letter. Some of the sections below contain comments on, or typical negotiating positions regarding, the clauses described. § .. position and duties clause The employment agreement usually begins with a description of the executive’s job title and responsibilities. Reciting the CEO’s position and duties is a simple task: “Executive

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will be the Chief Executive Officer of the Company, will report only to the Company’s Board of Directors, and will have day-to-day operating responsibility for the Company.” Setting out the CFO’s responsibilities will also be easy. Describing the job responsibilities of other members of the executive management team, however, will probably require more thought. Reciting the executive’s position and duties in at least some detail is important. The more detailed the description of the executive’s responsibilities, the less likely disputes will erupt down the road. Clear contracts lead to clear expectations. Furthermore, the more detailed the description of responsibilities in the employment agreement, the less likely the parties will fight if the executive later triggers a Good Reason to resign clause, assuming his employment contract contains one. A fairly typical “Good Reason” clause includes a trigger (the right to resign and collect separation benefits) for a “material diminution in duties, responsibilities, or authority.”17 When the executive’s duties, responsibilities, and authority are detailed in the employment agreement, the parties may have less to fight about. If a seat on the employer’s board of directors will be a part of the executive-employer relationship, then the employment agreement usually includes a clause requiring the employer to ensure the executive’s election (and continuing reelection) to its board while the executive is employed. The board requirement may be included in the employment agreement’s positions and duties clause or separately stated in another section of the employment agreement. § .. at-will employment clause The vast majority of executive employment agreements provide that the employment relationship is “at will.” This means either the employer or executive may terminate the executive’s employment, with or without notice, with or without cause, for any reason or no reason at all (except an illegal reason), at any time and any place. The at-will relationship is important to the employer because it does not want to be saddled with an executive it no longer believes can lead the company. The employer will invariably insist on inserting the following (or similar language) into the employment contract: “Executive’s employment is at will, and Executive’s employment may be terminated by the Company or the Executive at any time, with or without cause and with or without notice.” From the executive’s point of view, the issue is not whether the employment relationship is at will. For the executive, the critical issue is the scope and level of the protection contained in the employment agreement in the event the employer terminates the executive’s employment. The executive may modify the employer’s atwill clause as follows: “Executive’s employment is at will, and Executive’s employment

17

Good Reason clauses are discussed in greater detail in § 7.4.18.3.


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may be terminated by the Company or the Executive at any time, with or without cause, and with or without notice, providing that, in all cases, the termination is subject to all of the severance and equity acceleration terms in this employment agreement.” § .. term employment clause A term employment agreement is a contract for employment for a specific duration, called the “term” of the contract. For example, an employer and executive may sign a contract for a three-year term. This means that the employer has agreed to employ and pay the executive for three years, and in return, the executive has agreed to work for the employer for three years. In a term employment relationship, the employer may terminate the executive’s employment at any time, but then will be in breach of contract, and is usually required to continue to pay the executive’s salary and benefits for the remainder of the contract’s term.18 Similarly, the executive may quit his employment and cannot be forced to work for the employer (slavery and indentured servitude were outlawed years ago). But if the executive stops working, he will breach the term employment contract and by doing so may expose himself to a damages claim. The jilted employer’s damages may be as little as the employer’s cost of advertising and filling the vacant position. However, damages may be significantly higher if the executive’s breach causes extensive and foreseeable harm to his former employer.19 § .. best efforts clause Employment agreements invariably contain a recitation, in one form or another, that the executive will devote his best efforts to his employer and will not participate in any activity that competes with the company. This recitation may be separately stated in the employment agreement or incorporated in the employment agreement’s position and

18

See, e.g., Deal v. Consumer Programs Inc., 458 F. Supp. 2d 970 (E.D. Mo. 2005) (former employee entitled to remainder of salary under her one-year employment contract); Kittredge v. McNerney, 17 Mass. L. Rptr. 652, 2004 WL 1147449 (Mass. Super, May 7, 2004) (terminated employees entitled to remainder of their salary on their term employment contracts); Burge v. Western Pennsylvania Higher Educ. Council, Inc., 570 A.2d 536, 538–39 (Pa. Super Ct. 1990) (affirming damage award for employee where employer breached one year term employment agreement); Guiliano v. Cleo, Inc., 995 S.W.2d 88, 92, 96, 101 (Tenn. 1999) (constructively terminated director of marketing entitled to liquidated damages of the remainder owed under three-year term contract, plus interest). 19 See, e.g., Roth v. Speck, 126 A.2d 153, 155 (D.C. 1956) (reversing lower court’s finding that only $1 in nominal damages was due where employee breached an employment contract because “[t]he measure of damages for breach of an employment contract by an employee is the cost of obtaining other service equivalent to that promised and not performed. Compensation for additional consequential injury may be recovered if at the time the contract was made the employee had reason to foresee that such injury would result from his breach”); Equity Ins. Managers of Ill., LLC v. McNichols, 755 N.E.2d 75, 80–81 (Ill. App. Ct. 2001) (affirming arbitration award of $91,000 for employer against ex-employee who breached three-year term employment contract).

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duties clause. The following is an example this recitation might take: “Executive shall devote his best efforts and his full business time and services to the performance of his duties under this Agreement and shall not engage in any other employment, occupation, consulting or other business activity that conflicts with the business of the Company.” The employer’s best efforts clause rarely requires modification because the term simply confirms that the executive will do everything possible to make the employer a success, which is why the executive is joining the employer. However, executives are often actively involved in other non-conflicting business, professional, personal, community, and religious activities. To ensure that the best efforts clause does not restrict the executive’s ability to pursue his other interests, a statement should be added to the provision confirming the executive’s right to participate in these activities. Following is one example of a protective confirming clause: Notwithstanding any other term in this Agreement, Executive may engage in charitable, teaching, lecturing, religious, community service, volunteer, and industry association activities and manage his personal investments, as long as the activities do not interfere with the performance of his duties under this Agreement. Executive may also serve on other companies’ boards of directors or advisory boards, as long as the other companies do not compete with the Company and Executive’s service does not interfere with the performance of his duties under this Agreement. § .. compensation clause Compensation can take many forms. And in the world of compensation, one executive’s junk may be another executive’s treasure. Some executives are all about the “equity play,” which means they want as much equity as possible (e.g., more stock options, more restricted stock units) from a prospective employer because they believe this will earn them the most money. Others view equity as akin to corporate junk and look for the most lucrative commission or bonus plans or perquisites when they seek employment. Many sales forces, for example, are driven by cash compensation via commission plans rather than equity grants. Employment compensation discussions start with base salary, bonuses, commissions, and equity (or related) grants. Indeed, these compensation components will likely cover the entire compensation discussion at start-up and venture capital–backed private companies. At more mature companies, life insurance policies, mortgage assistance, top-hat deferred compensation plans,20 relocation payments, special perquisites, tax gross-ups,

20

Top-hat plans are unfunded employer plans maintained primarily to provide deferred compensation for a select group of executives or highly compensated employees. See, e.g., Sznewajs v. U.S. Bancorp


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reimbursement for professional bills, and more may be part of the executive’s employment negotiation. In addition, specific situations (e.g., employment contracts at private companies with high liquidation preferences or employment agreements arising from a merger and acquisition) may call for more specialized compensation arrangements. § 7.4.5.1 Base Salary The employment agreement’s base salary clause sets out the executive’s base salary. Base salary is the basic wage the employer pays the employee, less legally required withholding. Base salary is paid weekly, biweekly, bimonthly, or monthly, depending on the employer and applicable state law. Executives are almost always “exempt” employees and thus do not receive overtime pay.21 Some version of the following may be added at the end of the base salary clause: “The Company’s Board shall review Executive’s salary at least once a year and shall increase Executive’s salary if, in the sole discretion of the Board, an increase is warranted.” § 7.4.5.2 Bonuses and Commissions A bonus is typically additional compensation earned by a triggering employment event. The triggering event may be a definite milestone, such as “achieving fourth quarter profitability,” or discretionary, such as a bonus payable at the absolute discretion of an employer’s board. A commission is similar to a bonus but is typically based on sales of an employer’s products or services.22 Bonuses and commissions may be based on a formal plan, but they need not be. Bonuses and commissions come in myriad types. An employment agreement’s bonus and commission clause or clauses may build the bonus milestones or management-based objectives (MBOs for short) into the employment agreement or

Amended and Restated Supplemental Benefits Plan, 572 F.3d 727, 734 (9th Cir. 2009) (“ERISA defines a top hat plan as one which is unfunded and is maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees” (citations omitted)). They are subject to some, but not all, of ERISA’s requirements. Id. 21 29 U.S.C. § 213(a)(1). 22 See, e.g., Wilks v. Pep Boys, 278 Fed.Appx. 488, 489 (6th Cir. 2008) (for payment to qualify as commission under Fair Labor Standards Act, “the employer must establish some proportionality between the compensation to the employees and the amount charged to the customer”); Ramirez v. Yosemite Water Co., 978 P.2d 2, 14 (Cal. 1999) (commission is “compensation paid to any person for services rendered in the sale of such employer’s property or services and based proportionately upon the amount or value thereof”; for payment to qualify as a commission, employees “must be involved principally in selling a product or service, not making the product or rendering the service [and] . . . the amount of their compensation must be a percent of the price of the product or service”) (internal citations and quotations omitted); Borden v. Skinner Chuck Co., 150 A.2d 607, 610 (Conn. Super. Ct. 1958) (bonus is “not a gift or gratuity, but a sum paid for services, or upon a consideration in addition to or in excess of that which would ordinarily be given”) (internal citation and quote omitted); cf. Walling v. Plymouth Mfg. Corp., 139 F.2d 178, 182 (7th Cir. 1943) (“A bonus is a gratuity to which the recipient has no right to make a demand”).

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as an exhibit to the employment agreement. For example, the clause might provide: “Executive will be paid a bonus of 40 percent of his base salary if Company EBITDA23 is positive on or before December 31st.” On the other hand, the employment agreement may simply refer to the executive’s right to participate in a preexisting bonus or commission plan. For example, the clause may provide: “Executive shall participate in the Company’s 2011 commission plan.” Or the employment agreement may provide a combination of approaches. For example, the clause may state: “Executive shall participate in the Company’s 2011 Bonus Plan and shall earn a bonus of 100 percent of his base salary at target with a maximum potential of 150 percent of base salary.” Some executives negotiate hard on bonuses, pushing for a one-time sign-on bonus payable when employment begins; a guaranteed performance bonus for some period until the executive is able to learn the workings of his new employer; and thereafter, performance bonuses with clear, nondiscretionary milestones that will automatically trigger payments of set amounts when reached. On the other end of the spectrum, there are those who view the bonus as an extra, a perquisite which they are happy to leave to the board’s discretion. Where bonuses are an important part of the compensation package, the executive should understand when the bonus is “earned” and therefore payable to him. This knowledge may be important not only during the employment relationship, but also if the executive’s employment is terminated, especially where significant bonuses or commissions are owed. Among the ways bonuses or commissions may be earned are pro rata over time (e.g., work 100 days in a year and 100/365s of the bonus is earned), on a triggering milestone (e.g., 100 percent commission earned when sales reach $1 million), or on the payment date (e.g., commission earned only by those employed on the day the commission is paid). To determine whether a bonus or commission is earned, first look to the applicable plan or contract. Second, look to state law because state law may mandate when bonuses or commissions are earned. For example, in California, “[c]ommission wages are due and payable [and thus earned] when they are reasonably calculable,” not on the date the commissions are paid, regardless of whether the commission contract provides otherwise.24

23 24

EBITDA is the acronym for “Earnings Before Interest Taxes Depreciation and Amortization.” Cal. Dep’t of Industrial Relations, Div. of Labor Standards Enforcement, Enforcement Policies and Interpretations Manual (“CA DLSE Manual”), § 5.2.5, available at www.dir.ca.gov/ dlse/DLSEManual/dlse_enfcmanual.pdf; Schachter v. Citigroup, Inc., 218 P.3d 262, 271 (Cal. 2009) (“In . . . commissions on sales, it has long been the rule that termination [whether voluntary or involuntary] does not necessarily impede an employee’s right to receive a commission where no other action is required on the part of the employee to complete the sale leading to the commission payment”); See also CA DLSE Manual, § 35.5 (“If the employee is discharged before completion of all of the terms of the bonus agreement, and there is not valid cause, based on conduct of the employee, for the discharge, the employee may be entitled to recover at least a pro-rata share of the promised bonus”).


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§ 7.4.5.3 Dodd-Frank’s Clawback Requirements for Bonuses, Commissions and Other Payments If your executive client is joining a public company, make sure he understands Dodd-Frank’s new clawback rules for bonuses, commissions, and other incentive payments.25 Dodd-Frank requires the SEC to establish rules prohibiting national securities exchanges and associations from selling the stock of a public company unless the company implements a policy to “recover from any current or former executive officer [of the company] who received incentive-based compensation (including stock options awarded as compensation)” if the employer files “an accounting restatement due to the material noncompliance of the [employer] with any financial reporting requirement under the securities laws.”26 The employer is required to claw back (which means executives are obligated to pay their employer) the bonuses, commissions, and other incentive compensation company executives received “in excess” of what they would have received under the restated financial statements for the three years prior to “the date on which the [employer] is required to file [the] accounting restatement.”27 The regulations will cover all current and former executive officers, whether or not the executive officers were involved in misconduct.28 Because this book was published before the SEC established the implementing regulations necessary to give teeth to Dodd-Frank’s clawback requirements, it is unclear whether employers will begin insisting on including clawback language in executive employment contracts. It makes sense, however, that public employers (and private employers expecting to go public or sell themselves to public employers) will insist on clawback language. By including the language in executive employment agreements, employers will secure a contractual right to claw back their executives’ incentive pay.

25

§ 954 (Securities Exchange Act of 1934 § 10D). Id. The SEC plans to establish implementing regulations for § 954 in August–December 2011. SEC, Implementing Dodd-Frank Wall Street Reform and Consumer Protection Act – Upcoming Activity, www.sec.gov/spotlight/dodd-frank/dfactivity-upcoming.shtml (last reviewed Mar. 1, 2011). 27 Dodd-Frank § 954 (Securities Exchange Act of 1934 § 10D(b)(2)). 28 Id. Before Dodd-Frank and the Emergency Economic Stabilization Act of 2008, only CEOs and CFOs were subject to a clawback requirement, and that obligation is limited to a one year look back. Under § 304 of Sarbanes-Oxley, in the event a public employer is required to restate its financial statements, the company’s CEO and CFO are required to forfeit back to the employer all bonuses and incentive pay, and profits from selling the employer’s securities, they received during the one year period after the date the employer filed the offending financial statements. (Codified at 15 U.S.C. § 7243.) The SEC has begun seeking clawbacks under § 304 from CEOs and CFOs unaware of the misconduct that led their employers to file financial restatements. See, e.g., SEC. v. Jenkins, 718 F.Supp.2d 1070 (D. Ariz. 2010). The EESA, as amended by the American Recovery and Reinvestment Act of 2009, imposes a clawback requirement on the top twenty-five highest paid executives at companies receiving TARP or Capital Purchase Program funds. (Codified at 12 U.S.C. § 5221(a)(1), (b)(3)(B)). The clawback applies to bonus, retention award, or incentive compensation payments based on “materially inaccurate” “statements of earnings, revenue, gains, or other criteria.” (Codified at 12 U.S.C. § 5221(b)(3)(B)). 26

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In the absence of SEC implementing regulations and courts’ interpretations of both Dodd-Frank’s requirements and the SEC’s implementing regulations, Dodd-Frank’s clawback obligations raise multiple uncertainties, including the following: 1. What does “material noncompliance” mean? (The clawback applies only to “material noncompliance of the [employer] with any financial reporting requirement under the securities laws.”) Is there a difference between noncompliance and material noncompliance, and if so, what is the difference? Will courts (and arbitrators) accept the SEC’s definition of “material noncompliance,” or will courts (and arbitrators) issue their own definitions? 2. What does “in excess” mean and how will it be measured? (The clawback applies only to compensation received “in excess” of that which the executive would have received if the employer’s financials had been properly reported.) Is this uncertainty an invitation for a battle of the experts? 3. Which “date” triggers the three-year clawback period? (The three-year clawback period applies only to the three-year period before “the date on which the [employer] is required to file [the] accounting restatement.”) Is the correct date the date the employer first filed its inaccurate financial statements, the date the employer first advised the public that its inaccurate financial statements could no longer be relied on, the date the employer filed its restated financial statements, or some other date? 4. Who will qualify as “executive officers” for purposes of the clawback? (The clawback applies only to executive officers.) 5. Will time-based equity vesting (e.g., stock options vesting ratably over a fouryear period) be treated as incentive income subject to the clawback? Will the clawback regulations distinguish between time-based equity vesting and performance-based equity vesting?29 (The clawback applies to “incentive-based compensation [including stock options awarded as compensation].”) 6. Will the clawback be imposed on executives’ pre-tax or post-tax income? For example, if an executive in the 50% combined tax bracket earned $1,000,000 of incentive compensation subject to a clawback, is the employer required to claw back (and the executive required to repay) $1,000,000, $500,000, or some other amount? 7. Who will make the determination about when a clawback is required and the magnitude of the “excess” income? 8. What effect, if any, will state wage and employment laws have on the implementation of Dodd-Frank’s clawback requirements?30

29 30

See § 4.4.2 and § 7.4.6.2 for a discussion of time-based and performance-based vesting. States have varying prohibitions against employers applying offsets to employees’ wages. See e.g., Mich. Comp. Laws § 408.477 (“Except for those deductions required or expressly permitted by law or by a collective bargaining agreement, an employer shall not deduct from the wages of an employee. . . without


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9. Under what circumstances, if any, will the employer be permitted to negotiate a clawback settlement with the executive, release the executive from potential (or additional) clawback liability, or waive clawback liability?31 10. Will executives with employment agreements negotiated before the SEC’s clawback regulations take effect be required to renegotiate their employment agreements? May an employer’s attempt to amend a pre existing executive employment agreement to add a clawback requirement trigger a Good Reason to resign clause under the agreement? 11. What should executives do with incentive income subject to the clawback (how should they invest the income) during the three-year exposure period? 12. How will the clawback requirement affect employer-executive employment negotiations? § .. equity clauses: key clauses that may appear in employment and equity agreements The amount of equity and the terms that will attach to the equity are often a driving force in the negotiations between the executive and his prospective employer. Key business terms of the executive’s equity grant are frequently written into the employment agreement. This happens because the parties negotiate equity terms at the same time they negotiate the employment agreement, and then the negotiated equity terms are memorialized in the employment agreement. The employer-employee’s equity contracts often describe the employment agreement’s equity business terms in much greater detail than the employment agreement. For

the full, free, and written consent of the employee . . . .”); N.Y. Labor Law § 193 (prohibiting deductions from wages, except for deductions “made in accordance with the provisions of any law or any rule or regulation issued by any governmental agency”); Tex. Labor Code § 61.018 (prohibiting garnishment of wages, except when “ordered to do so by a court of competent jurisdiction” or “authorized to do so by state or federal law”). 31 In Cohen v. Viray, 622 F.3d 188, (2d Cir. 2010), a case involving Sarbanes-Oxley’s § 304 clawback requirement, the SEC and Department of Justice (“DOJ”) objected to a class action and derivative settlement because the settlement released executive officers from § 304’s clawback requirement and indemnified the officers in the event of later government action. The SEC and DOJ asserted that the release and indemnification provisions were illegal and effectively nullified “the SEC’s authority to pursue the § 304 remedy or to grant exemptions from the statute.” Id. at 194. The Second Circuit agreed and vacated the settlement. Id. at 196. Cohen (and Cohen’s logic) may not apply to Dodd-Frank’s clawback requirement because the enforcement mechanisms of the Sarbanes-Oxley and Dodd-Frank clawbacks differ. Under § 304 of SarbanesOxley, there is no private right of action. Id. at 193; In re Digmarc Corp. Derivative Litigation, 549 F.3d 1223, 1233 (9th Cir. 2008); Pirelli Armstrong Tire Corp. Retiree Med. Benefits Trust ex rel. Fed. Nat’l Mortg. Ass’n v. Raines, 534 F.3d 779, 793 (D.C.Cir. 2008). Only the SEC enforces § 304’s clawback requirement and thus, an attempt by an employer to compromise a § 304 claim impermissibly affects the government’s ability to enforce the securities laws. By contrast, under Dodd-Frank § 954, the employer, not the SEC, is required to enforce the clawback. Future SEC regulations should, therefore, provide at least some authority to the employer to settle a clawback dispute.

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example, vesting, which is a key business term, may be described in one or two sentences in the employment agreement, whereas the vesting clause in the equity contract may consume multiple paragraphs. The “business deal,” however, should not change. Consequently, the discussion about equity clauses in the following sections may be used to understand both equity terms contained in the employment agreement and the often more detailed provisions contained in the employer’s separate equity contracts. The employment agreement usually references other equity agreements or corporate documents, such as the employer’s form stock option agreement or equity plan. These documents, as with all documents referenced in the employment agreement, should be reviewed contemporaneously with the review of the employment agreement. Otherwise, it is impossible to understand the entire job offer. § 7.4.6.1 Types of Equity There are many types of equity and phantom equity compensation arrangements. Two common forms of equity compensation are the employee stock option and the restricted stock unit agreement. The employee stock option gives the employee the option to purchase shares of his employer’s stock at a fixed price. The restricted stock unit agreement gives the employee the right to receive a predetermined number of shares of the employer’s stock at predetermined times or events. Both are discussed below. § 7.4.6.2 Vesting Vesting is the rate at and process by which an executive obtains the right to a benefit. In the case of employee stock options and restricted stock units, vesting means the rate at and process by which the employee obtains a right to exercise his option or a right to delivery of the stock underlying the restricted stock units. The vesting schedule is absolutely critical because until equity “vests,” the executive has no right to the equity. Vesting is usually either time based or performance based (sometimes it is a combination of both methods). With a time-based vesting stock option, the employee’s right to exercise the option and purchase the employee’s stock vests over a period of time, providing the employee remains employed by the company. By contrast, with performance-based employee stock options, the employee’s right to exercise the stock option and purchase the employer’s stock vests when the employee achieves predetermined performance milestones described in the stock option. Time-based vesting may be cliff vesting, pro rata vesting, or a combination of the two. Cliff vesting means that vesting does not occur until some point in time, the cliff, at which point some or all of the option vests. Pro rata vesting means that the option vests in equal installments (typically monthly or quarterly) until fully vested. A common vesting schedule for a private Silicon Valley high-tech company is a one-year cliff with pro rata vesting for three years thereafter. This means that 25 percent of the stock subject to the option cliff vests at the first anniversary of employment and 1/36th of the remaining number of shares subject to the option vest


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in equal monthly installments thereafter, until the entire option vests in four years. Variations of this vesting schedule include four cliff vests of 25 percent of the stock subject to the option at the first four anniversaries of employment, and monthly pro rata vesting of 1/48th of the shares subject to the option over four years. § 7.4.6.3 Maximum Term of the Option All employee stock options subject to a qualified equity plan have a maximum term, after which they expire, regardless of whether or not the employee is working for the employer. The maximum possible term of the option is ten years, and option terms are usually seven to ten years, although they could be for any period less than ten years.32 Some employment agreements set out the term of the option in their text. If the employee’s employment is terminated prior to the end of the maximum option term, most employee stock options terminate before the maximum term of the option. Many employee stock options provide that they terminate within 90 days of the last day of employment. § 7.4.6.4 Option Granted at Board’s Discretion An employee stock option granted pursuant to qualified plan by a Delaware corporation must be granted by the company’s board of directors (or an authorized subcommittee of the board), not by management.33 The grant is usually made on or after the first day of employment. For this reason, employment agreements frequently state that the option is “subject to board approval.” Given that equity grants often are often heavily negotiated and critical components of an executive’s compensation package, the obvious question is: “What happens if, at the end of the day, the board refuses to grant the employee stock option?” As a practical matter, this almost never happens. When an employer is hiring a CEO or other board-appointed executive, the board is usually informed of the negotiations as they progress or has appointed a director or other trusted person to negotiate. When an employer is hiring a lower level executive, the board will almost always back management’s recommendations. However, to add an additional level of protection, the following clause may be included in the employment agreement: “Management represents, in good faith, that management believes the board will approve Executive’s stock option.”

32 33

26 U.S.C. § 422(b)(2)–(3). Del. Code Ann. tit. 8, § 157(b), (c). The terms of the stock option may, in the alternative, be listed in the Delaware corporation’s certificate of incorporation. Id.; Other states also require boards of companies incorporated in their state to authorize the issuance of stock options. See, e.g., Fla.Stat. § 607.0621; 805 Ill. Comp. Stat. 5/6.25(a); 2 Tex. Bus. Orgs. Code Ann. § 21.157; See also 26 U.S.C. § 422(b)(1) (qualified stock option plans must be approved by the shareholders).

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§ 7.4.6.5 Fair Market Value and Risk Assignment The goal of most employers’ boards of directors is to set the exercise price of the company’s employee stock options at the fair market value of a share of the company’s common stock on the date of the option grant. If the executive is joining a public company, the exercise price of the executive’s employee stock option will be based on the public market price of the company’s common stock because the public market price is the “fair market value” of the employer’s stock. The public company often sets the stock option exercise price as the closing price of the employer’s stock on the date the option is granted. However, a number of other stock market–based pricing methodologies are authorized by applicable federal regulations for use as the “fair market value” price.34 Because private companies’ boards have no public market to help them set their stock price, the executive’s first thought may be to negotiate a below market price for his employee stock option. By doing so, the executive logically reasons, he will receive a financial upside before his employment begins. Logic, in this instance, runs straight into the dictates of I.R.C. § 409A.35 Almost all employee stock options granted with exercise prices below fair market value will trigger § 409A’s onerous taxation requirements, including an additional 20 percent excise tax and interest and penalties.36 Since the passage of I.R.C. § 409A, a new cottage industry of § 409A valuations has developed. Under § 409A, an independent, experienced, third-party valuator’s valuation of the fair market value of a private company’s common stock provides a fair market value safe harbor against IRS action.37 Throughout the country, private company boards are purchasing § 409A valuations as a form of insurance against potential claims that they set the price of their employee stock options below fair market value. Independent third-party valuations are good for up to 12 months, although significant company events may render a valuation outdated earlier.38 Executive employment agreements sometimes include a clause assigning the tax risk associated with the possibility that the employer is granting the employee stock option at an exercise price below fair value. The employer, of course, hopes to explicitly assign the risk to the executive. Employers’ form stock option agreements increasingly

34

See Treas. Reg. § 1.409A-1(b)(5)(iv)(A). 26 U.S.C. § 409A; Treas. Reg. § 1.409A, et seq. 36 Treas. Reg. § 1.409A-1(b)(5)(i). Some states impose additional excise taxes on § 409A income. Providing applicable state law permits the use of § 409A compliant vesting, it is possible to offer stock options at exercise prices below fair market value which comply with § 409A’s regulations, but, as a practical matter, most employer plans do not contain the appropriate language (nor is it clear an executive would favor § 409A compliant vesting). 37 Treas. Reg. § 1.409A-1(b)(5)(iv)(B)(2)(i). 38 Id. Section 409A valuations can be somewhat of a sham in certain situations. The valuation is supposedly independent, but an independent valuator must do its due diligence before rendering the valuation decision. Due diligence may include discussing the target company’s finances with the company’s CFO. During that valuator-CFO discussion, the valuator may “wonder” what the company believes about the fair market value of its stock. 35


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contain clauses stating that fair market value determinations are inherently uncertain; that the executive relies only on his personal tax advisors for tax advice; and that the executive bears the risk of paying additional taxes, penalties, and interest in the event the IRS later determines the employer granted the stock option at a price below fair market value. The executive, on the other hand, hopes to add a clause to the employment agreement (or stock option agreement) assigning the § 409A tax risk to the employer. The most protective executive clause will require the employer to gross-up the executive for all taxes, penalties, and interest arising out of a government taxing authority’s determination that the executive’s stock option was granted at a price below fair market value.39 § 7.4.6.6 Changing the Terms of the Stock Option After it Is Granted An in-the-money employee stock option40 should not be revised to the benefit of the employee after it has been granted, except to accelerate vesting or increase the post-termination exercise period as permitted by § 409A’s regulations.41 Revising an in-the-money employee stock option with terms more favorable to the employee after the stock option is granted may cause negative tax consequences under § 409A.42 Stock options may be revised after they are granted if they are underwater, providing the new exercise price is equal to or above fair market value on the date of the revision. The revised underwater option will be treated as a new option for § 409A purposes.43 § 7.4.6.7 Anti-Equity Forfeiture Provisions Some states permit companies to include forfeiture provisions in their stock option agreements. For example, a forfeiture clause may provide that an employee terminated for Cause forfeits all his company stock options, including those which vested over prior years.44 Beware of forfeiture provisions and the perverse incentives they may

39

If the executive receives stock options from a company other than his employer, the stock option may or may not be § 409A compliant, depending on the circumstances. 40 An in-the-money employee stock option is a stock option with shares that have a fair market value higher than than the exercise price of the shares. Thus, if the employee were permitted to exercise the stock option and sell the shares delivered to him upon exercise, the employee would make money. A stock option with shares that have a fair market value lower than than the exercise price of the shares is frequently referred to as an “underwater” stock option. 41 See discussion at §§ 7.4.1.18.6.3, 7.4.18.6.4, 9.5.6 and 9.5.7. 42 The option will be treated as a “new” option grant. If the fair market value of the “new” option on the date of modification is higher than the exercise price, § 409A and a retroactive 20 percent excise tax may apply. See Treas. Reg. § 1.409A-1, et seq.; see also Internal Revenue Service, 409A Regulations and Guidance, available at www.irs.gov/retirement/article/0,id=186222,00.html (last updated Sep. 23, 2010). 43 Treas. Reg. § 1.409A-1(b)(5)(v)(A)-(B). 44 See, e.g., Noonan v. Staples, Inc., 556 F.3d 20 (1st Cir. 2009) (applying Massachusetts law); Weir v. Anaconda Co., 773 F.2d 1073 (10th Cir. 1985) (applying Kansas law); Rosenberg v. Salomon, Inc., 992 F.Supp. 513 (D. Conn. 1997) (applying New York law); see also Archer Daniels Midland Co. v. Whitacre, 60 F.Supp.2d 819, 832 (C.D.Ill. 1999) (whether vested options are rescindable upon termination for cause

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create for an employer (or manager or board) to aggressively terminate for Cause the employment of an employee with millions of dollars of in-the-money stock options. Some states—California, for example—prohibit private companies from including forfeiture clauses that cover vested stock options.45 In California, the employer may buy back the vested stock at fair market value but not usurp it.46 When the executive is faced with equity agreements that contain vested equity forfeiture provisions, the executive should insist on including an anti-forfeiture clause in his employment agreement (or stock option agreement). The following clause is one example of an anti-forfeiture clause: “Notwithstanding any other term in this employment agreement or the stock option agreement, Executive’s vested employee stock options shall never be subject to forfeiture and may be exercised in whole or in part at any time up to and including . . . .” This clause protects the executive from the specter of strategic terminations for Cause. § 7.4.6.8 Anti-Buy-Back Provisions Beware, too, of private employer stock option agreement buy-back provisions that permit the employer to repurchase, after the termination of employment, all company stock purchased through the exercise of employee stock options. Buy-back provisions come in different flavors. Some set the repurchase price at book value, others at a predetermined (typically depressed) value, and still others at fair market value.47 Forced repurchase clauses often deprive the private company executive of his hardearned equity upside, especially if the stock repurchase price is set below fair market value. Even where the buy-back price is set at fair market value, the repurchase clause may deprive the executive of expected gain and a liquidity premium in the event the company goes public. Repurchase clauses cannot be ignored, but they may be addressed by adding a clause to the employment agreement nullifying all buy-back provisions. Executive Story Jessica took a job as executive vice president at a private company that had aggressively recruited her. Excited about the opportunity, Jessica began working before completing her employment contract.

constitutes a genuine issue of material fact); but see Scientific Drilling Intern., Inc. v. Pathfinder Energy Services, Inc., 2006 WL 2882863, at *4 (S.D.Tex. Oct 4, 2006) (equity plan’s language did not permit forfeiture when employees voluntarily left and were not discharged for cause). 45 10 Cal. Code Regs. tit. 10, § 260.140.8(b)(4). In the event of termination of employment for cause in California, the employer need not give the employee any post-termination period to exercise the option. Cal. Code Regs. tit. 10, § 260.140.41(e). 46 10 Cal. Code Regs. tit. 10, § 260.140.8(b)(4). 47 Note that an employee stock option is probably not compliant with § 409A if it contains a forced buyback provision for vested stock at a repurchase price below fair market value. Treas. Reg. § 1.409A-1(b)(5) (iii)(A). Rights of first refusal and clauses permitting repurchases of unvested stock for a price below fair market value (e.g., at the exercise price) are permissible under § 409A. Id.

Pre-Employment: Negotiating the Employment Contract and Related Agreements During her first week in her new position, Jessica asked me to review her unsigned employment agreement and related documents. The employee stock option agreements Jessica had received from her prior employers provided that once she exercised her stock options for vested stock, the stock belonged to Jessica, come hell or high water. That is what Jessica thought she was receiving when her new employer presented her with her stock option agreement. Not so. Jessica’s employment and stock option agreements at her new employer contained two disturbing clauses. The first allowed Jessica’s employer to repurchase Jessica’s stock if Jessica left the company’s employ at any time before the company went public. The second disturbing clause required Jessica to forfeit all of her company stock in the event her employer terminated Jessica’s employment with Cause. I called Jessica: “So Jessica, are you working at your new employer only for salary and bonus, or does equity have anything to do with why you are working there?” “No, equity is a big reason why I’m here,” Jessica assured me. “Do you realize that the company’s stock option agreement says you can be forced to sell your equity back to the company if you leave the company after you vest and purchase all your stock?” I asked. “You could also lose all of your equity if someone decides you’re not doing a good job and fires you for cause,” I continued. “What do you mean?” Jessica asked. “I mean that you may be working for no equity.” “We can’t have that, now can we?” The new employer put up a fight. In discussions with her employer over the next many months, Jessica heard just about every justification for equity repurchase and forfeiture clauses known. At one point, the company’s chairman of the board assured Jessica that it would be inequitable and unfair for only one person on the management team to have a special equity clause. Although she was otherwise happy in her new position, Jessica grew increasingly frustrated over the company’s intransigence on the equity front. Eventually she decided to look for another job. Jessica is very good at what she does. During her seven months on the job, she had turned around the company’s operations and done a stellar job focusing the sales and marketing team on pushing the company’s core products. Everyone loved Jessica, including the company’s board and CEO. They worried that Jessica’s refusal to sign her employment and stock option agreements might cause Jessica to leave the company.

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They became frantic when they discovered, via the grapevine, that Jessica was actively looking for another job. Immediately thereafter, the employer caved, agreeing to grant Jessica stock options sans forfeiture and forced buy-back clauses.

§ 7.4.6.9 Anti-Dilution Clause The purpose of an employment agreement’s anti-dilution clause is to stabilize the executive’s ownership interest in his (typically private) employer for a period of time. Anti-dilution clauses are often difficult for the executive to negotiate, except when the executive joins a private employer immediately before a large expected capital raise. In such a situation, an anti-dilution clause may be a critical consideration in the executive’s employment negotiation. There are many types of protective anti-dilution clauses. Following is one example: In the event the Company receives a capital investment of [$___ ] million or more in one or a series of related transactions at any time in the next [ ___ ] year[s], after the close of the financing transaction or each related transaction, as applicable, the Company shall promptly grant Executive an option for that number of shares which will ensure that all of the shares subject to all of Executive’s employee stock options equal or exceed [ ___ ] percent of the fully diluted capital of the Company on an as converted to common stock basis. Dilution occurs when a company issues stock. Dilution may be extreme when a company with a low valuation accepts significant investment. For example, an employer valued at $1 million pre-money (before investment) that receives $1 million in outside investment and is valued at $2 million post-money (after investment) has just sold 50 percent of its equity. The executive with a 10 percent ownership interest in this employer pre-financing sees his equity ownership in the company (in terms of percentage of the company he owns) cut by 50 percent to 5 percent. By contrast, the employer valued at $9 million (pre-money) that sells $1 million of its stock (and a post-money valuation of $10 million) has sold only 10 percent of its stock. In this situation, the executive sees his equity ownership cut by only 10 percent. A prospective employer faced with an executive’s anti-dilution demand sometimes responds by offering a greater initial equity grant. A large equity grant diluted to a lower ownership percentage post-financing is functionally equivalent to an initial grant of non-dilutable equity at the same lower percentage. The parties should be economically neutral as to the mechanism chosen, providing the price of the equity is the same in both situations (but they may not be neutral for various reasons, including the potential difficulties that anti-dilution clauses may create with outside investors contemplating an investment in the company).48

48

In many private investor–backed companies, investors have anti-dilution protection. Investor anti-dilution protection often comes in the form of a “pay to play” clause. “Pay to play” is an investor


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§ 7.4.6.10 Early Exercise Provision An early exercise clause in an employment or stock option agreement permits the employee to exercise the stock option before the option vests. The purchased but unvested stock is usually subject to repurchase by the employer at the lesser of the exercise price or fair market value. In the event the employee exercises his stock option early and then leaves his employment, the employer, at its election, may repurchase the unvested stock at the option exercise price or fair market value, if fair market value is less than the exercise price. Alternatively, the employer may keep the money the employee paid to exercise the stock option and allow the employee to retain his stock. Following is an example of an early exercise clause: “Executive’s stock option shall be immediately exercisable, providing that unvested stock subject to the option shall be subject to repurchase by the Company at the lesser of (i) the option exercise price or (ii) fair market value.” Early exercise clauses are tax-driven provisions. Employees who exercise a stock option early usually do so because they expect the stock to appreciate in value and want their appreciated stock taxed at the capital gains rate rather than the ordinary income rate. The early exercise process is a three-part process: First, the employee negotiates an early exercise clause into his employment or stock option agreement (some employers include an early exercise clause for all of their employee stock options). Second, the employee exercises his stock option by completing the appropriate forms and paying for the stock within 30 days of the stock option grant date (presuming the employee wants to file an 83(b) election). Third, within 30 days of the stock option grant date, the employee completes and submits an 83(b) election to the IRS.49 The 83(b) election allows the executive to pay the taxes due on the difference between the fair market value of the stock and the exercise price of the stock on the option exercise date. On the date of exercise (which must be within 30 days of the date of grant), the fair market value of the stock is invariably the same as the exercise price of the stock, meaning the executive pays no taxes when he files the 83(b) election because there has been no gain. By filing the 83(b) election and paying taxes (usually $0) on the exercised stock up front, all later taxes owed on the sale of the stock (presuming the stock is held for at least one year) are capital gains taxes payable at the time of the sale of the stock.50 When the executive exercises his employee stock option early and files an 83(b) election, the executive takes the risk that he will lose the money he pays for the stock.

protective measure that guarantees the investor the right to buy that number of shares in later rounds of a company’s financing(s), which will keep the investor at the percentage of equity ownership the investor had after its early round investment. 49 26 U.S.C. § 83(b). 50 If the executive early exercises his stock option and does not file an 83(b) election, then a taxable event occurs every time stock subject to the option vests. The difference between the fair market value of the stock when the stock vests and the option exercise price will be taxed as ordinary income. 26 U.S.C. § 83(a). Section 409A does not apply to property received under § 83(b). Treas. Reg. § 1.409A-1(b)(6).

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If the company fails, the stock will have no value. Even where the shares increase in value, the stock may be illiquid for many years. § 7.4.6.11 Right of First Refusal Right of first refusal (ROFR) clauses are ubiquitous in private companies’ equity agreements, including in their employee stock option and restricted stock unit agreements. The ROFR gives the private company employer, or its assignee (e.g., the employer’s investors), the right to purchase its employee’s company stock in the event the employee attempts to sell or otherwise transfer the stock to a third party. The ROFR typically gives the employer a set amount of time (e.g., 30 days) to exercise its ROFR and purchase the employee’s stock on the same terms and conditions as the third party proposes to buy the stock. If the employer declines to exercise its ROFR, the employee may sell the stock to the third party for a period of time (e.g., 60 days). Transfers of private company stock to an employee’s immediate family members and trusts for the benefits of these family members are often exempt from the employer’s ROFR. § 7.4.6.12 Incentive Stock Options (ISOs) vs. Non-Qualified Stock Options (NQSOs) A clause in the employment agreement may state whether the options granted to the employee will be non-qualified stock options (NQSOs) or incentive stock options (ISOs). With NQSOs, the difference between the fair market value of the stock on the day the option is exercised and the exercise price of the stock option is the taxable gain.51 NQSOs are taxed at the executive’s ordinary income rate, and the taxable event occurs on the exercise date. With ISOs, there is no regular federal income tax liability upon the exercise of the option, although the difference, if any, between the fair market value of the stock on the date of exercise and the exercise price will be treated as income for federal alternative minimum tax purposes and may cause the employee to owe alternative minimum tax in the year the executive exercises his stock option.52 If the executive holds the stock purchased when the ISO is exercised for one year after the date of exercise and two years after the date of grant, then the gain between the sales price of the stock and the exercise price of the stock option is taxed as long-term capital gains at the time the stock is sold.53 Stock delivered on the exercise of an ISO that is sold within two years of the option grant date or within one year of the date of the option exercise is disqualified for ISO

51

26 U.S.C. § 83(a); Treas. Reg. § 1.83–7. 26 U.S.C. § 55. Consulting a tax advisor is particularly important because an executive or entrepreneur early exercising his stock option and filing an 83(b) election might choose NQSOs over ISOs to avoid the impact of the alternative minimum tax. 53 26 U.S.C. § 422(a); Treas. Reg. § 1.422–1. 52


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tax treatment and is, thereafter, treated as stock derived from a non-qualified stock option.54 No more than an aggregate of $100,000 (as determined by the exercise price of the stock option) in share value subject to options may be granted as ISOs in any year to one employee.55 This $100,000 limit extends to all of the employee’s employee stock options exercisable each year. All shares subject to employee options that are over an employee’s $100,000 per year limit are converted to non-qualified stock option shares.56 § .. employee benefits The employee benefits clause in an employment agreement describes the employee benefits the executive will enjoy if he joins the employer. Often this clause simply states that the executive will be entitled to the employer’s standard employee benefits. Employee benefits vary widely by employer. They may include medical benefits, vision benefits, dental benefits, 401(k) retirement plans, SERPS or other retirement plan benefits, disability benefits, life insurance benefits, health savings plan benefits, and more. The executive should review all of his prospective employer benefit plans before joining the company. § .. reimbursement of expenses Employment contracts frequently include a clause requiring the employer to promptly reimburse the employee for all business expenses incurred in the course and scope of employment. One example of an expense reimbursement clause: “Company shall promptly reimburse Executive for all business expenses Executive incurs in the course and scope of his employment in accordance with the Company’s expense reimbursement policy.” Perquisites (e.g., executive always flies business class) may also be added to the reimbursement of expenses clause. § .. other employee benefits or perquisites Employment agreements often contain one or more additional clauses setting out other benefits or perquisites the executive will receive. For example, the employment agreement may contain a clause describing employer-provided relocation benefits, employer-provided retirement benefits, or employer-provided transportation (e.g., aircraft usage) benefits.

54

Under 26 U.S.C. § 422(a) and Treas. Reg. § 1.422–1, there will be a disqualifying disposition. The ISO option also becomes a NQSO in the event the option is exercised more than three months after employment terminates. 26 U.S.C. § 422(a)(2); Treas. Reg. § 1.422–1(a)(1)(i)(B). 55 26 U.S.C. § 422(d); Treas. Reg. § 1.422–4. 56 For a detailed analysis of employee stock options, see Carol Cantrell, Stock Options: Estate, Tax and Financial Planning (CCH 2010).

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§ .. reimbursement for attorneys’ fees for review of employment-related documents Many, although by no means all, prospective employers will pay the attorneys’ fees that their prospective executives incur in connection with the negotiation of their employment-related documents.57 Others agree to pay the prospective executive’s attorneys’ fees up to a predetermined cap. For the prospective employer, it is a small cost of doing business. An example of an attorneys’ fees reimbursement clause follows: “The Company shall pay the attorneys’ fees incurred by the Executive in connection with the review and negotiation of this Agreement and all related agreements [up to $_______].”58 § .. indemnification and insurance clause § 7.4.11.1 Indemnification Indemnification clauses and agreements are absolutely critical, especially for officers and directors of public companies.59 Lawsuits can be extraordinarily expensive to defend, settlements astronomically high, and judgments financially debilitating. The employment agreement’s indemnification clause does one of three things: (1) confirms that the parties will enter into the employer’s form (or other) indemnification agreement; (2) turns the executive into a direct obligee, rather than a third-party beneficiary, of the employer’s obligation to indemnify the executive pursuant to indemnification clauses in the employer’s corporate documents, such as its bylaws; or (3) provides indemnification language that obligates the employer to indemnify the executive. One critical clause in executive indemnification agreements is the provision requiring the employer to immediately advance all costs and expenses (including attorneys’ fees) to the executive involved in any arguably indemnifiable claim. The “expense advancement” clause protects the executive against having to personally front the costs of a company-related investigation or litigation.60

57

State ethics codes may require the attorney to obtain informed written consent from his client before accepting payment from third parties. See, e.g., D.C. Rules of Prof’l Conduct R . 1.8(e) (requiring “consent after consultation”); La. Rules of Prof’l Conduct R . 1.8(f) (requiring informed consent from client unless the third party pays pursuant to a contract, as in the case of insurance or a prepaid legal plan); Mass. Rules of Prof’l Conduct R . 1.8(f) (requiring client “consent[] after consultation”); N.Y. Prof’l Conduct Rules § 1200.08(f) (requiring informed, but not written, client consent); Tex. Rules of Prof’l Conduct R . 1.08(e) (requiring client consent). 58 For optics reasons, some employers prefer to use a sign-on bonus (or increase the size of a proposed guaranteed bonus) to pay for the prospective executive’s attorneys’ fees. Some mature employers reimburse management team members for accounting and attorneys’ fees incurred by their executives during the year. 59 Prospective officers or directors should require an indemnification agreement and D&O insurance before agreeing to serve as an officer or director of a publicly traded company. 60 See Jennifer A. Waters and Peter V. Baugher, Advancing D&O Litigation Expenses: The Power of the Perk, 99 III. Bar J. 36 (2011). The executive may be required to sign an undertaking, which provides that the


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Corporate boards regularly approve indemnification agreements for their officers and directors.61 In situations where the prospective employer already has a preapproved indemnification agreement (or where it is does not have one but is willing to enter into one), the employment agreement’s indemnification clause should state that the employer and employee will enter into the company’s indemnification agreement contemporaneously with entering into the employment agreement. An employment agreement might provide: “Company and Executive shall enter into the Company’s standard indemnification agreement at the same time the parties enter into this Agreement. [The indemnification agreement is attached as Exhibit __].” Some employers write their indemnification obligations into their bylaws or other corporate documents, making the officer or director a third-party beneficiary of the employer’s agreement to indemnify. In these situations, the executive should include a clause in his employment agreement confirming the employer’s obligation to indemnify him, which will create a direct contractual obligation to indemnify. The following clause is an example of one that may be included in an employment agreement: “Company shall indemnify Executive to the fullest extent provided for in the Company’s bylaws.” Indemnification obligations written into corporate documents must be read very carefully. Some provide for mandatory indemnification only of company directors and board-elected officers, and discretionary indemnification, as determined by the board, for everyone else. If indemnification is discretionary for your executive client, the employment agreement should contain a representation that the board will approve, and the company will provide, full indemnification to the executive. Where no preexisting form indemnification agreements and no corporate indemnification obligation exists, the employment agreement should be drafted to include a clause requiring the employer to fully indemnify the executive. Following is a short clause with an example of indemnification language: Company shall indemnify Executive to the fullest extent permitted by [Delaware law] [and/or other state law applicable to the corporation including, possibly, the state in which employment will take place] for all claims, allegations, investigations, or settlements of any kind brought or alleged to be brought against Executive, at any time, for any act or omission in any way related to Executive’s service to the Company, and in connection with this obligation, the Company shall immediately advance all costs and expenses, including attorneys’ fees, to Executive at any time Executive demands an advancement of costs and/

executive will return the advanced funds in the event the executive is found to have committed an unindemnifiable act. 61 Form indemnification agreements approved by boards of public companies are publicly available at www.edgar.com or www.sec.gov.

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or expenses. The Company’s obligation to indemnify Executive shall be construed as broadly as possible. § 7.4.11.2 Insurance Insurance coverage issues are naturally addressed in the section of the employment agreement requiring indemnification. For executives joining public companies (that presumably have purchased insurance coverage), the following term may be added: “[Executive shall be a named insured on] [Executive’s position shall be specifically covered by] all of the Company’s directors and officers, employment liability, and errors and omissions insurance policies (and all substantially similar insurance policies) so that Executive is fully covered by all policies at all times during and after Executive’s employment.” Many private employers do not have D&O, EPL, or E&O insurance. These employers may have concluded that the cost of one or more of the policies outweighs the advantage of the insurance coverage. In these circumstances (where the executive agrees to join the company without requiring the prospective employer to purchase insurance), the following term may be added to the employment agreement: “In the event the Company purchases one or more directors and officers, employment liability, and/or errors and omissions insurance policies (or substantially similar insurance policies), then [Executive shall be a named insured on] [Executive’s position shall be specifically covered by] all of the Company’s policies so that Executive is fully covered by all policies in force at all times during and after Executive’s employment.” Given the significant expense involved in defending securities class action and securities-related derivative cases, and the sometimes astronomical damages that may result from securities fraud, most public employers purchase D&O insurance policies. When your executive client considers joining a public employer as a senior officer and/ or director, you should determine whether the prospective employer’s D&O insurance is sufficient to provide coverage in the event that securities fraud class action or securities-related derivative cases are filed against the company and/or the executive. Whether D&O coverage is sufficient depends on a number of factors, including the amount of coverage purchased, the price and volatility of the prospective employer’s stock, and the ability of the employer to indemnify the executive.62 If you have any doubt about the sufficiency of the D&O coverage, you should read the prospective employer’s policies. You should also instruct your client to discuss them (or you should discuss them directly) with the would-be employer’s chief financial officer (usually responsible for purchasing the policies) and the company’s insurance agent. At a minimum, your executive client (or you) should ask the following direct

62

The strongest indemnification agreement may provide little or no protection if the employer files for bankruptcy.


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questions, and your client should be completely satisfied with the answers he receives: • “How much D&O coverage has the company purchased?” • “Is the company’s D&O coverage sufficient to protect the company and all company executives if securities class action and securities-related derivative cases are filed against them?” • “Why is the company’s D&O coverage sufficient to cover the company and its executives?” If your executive client is unsatisfied with the responses, he may add increasing D&O coverage limits as a demand in his employment negotiation. If the demand is reasonable, the company will probably accede to the request because the interests of all of the company’s directors and officers (including the CFO usually responsible for purchasing the insurance) are aligned when it comes to the company buying sufficient D&O coverage. § .. ciiaa clause In most cases, the employment agreement’s CIIAA clause will simply state that the executive’s employment is contingent on signing the employer’s confidential information and invention assignment agreement. Sometimes the employment agreement’s CIIAA clause will detail the executive’s responsibility with respect to the employer’s confidential and proprietary information and trade secrets. In these situations, the employment agreement’s CIIAA clause takes the place of a separate CIIAA agreement. § .. company policy and/or employee handbook clause Most employers have an employee handbook that describes the companies’ policies. Many companies require their employees to sign an acknowledgment that they have read the employee handbook, and this requirement may be included in the employment contract. The prospective employer’s employee handbook and policies should be reviewed before the executive joins the company. If the employee handbook contains clauses that contradict or negate the terms of the negotiated employment agreement, then a clause should be added to the employment agreement providing that the terms of the employment agreement take precedence over the terms of the company’s employee handbook.

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§ .. confirmation of parties’ entry into other agreements If the executive will enter into separately stated agreements (e.g., change in control agreement or management carve-out agreement)63 at the same time that, or shortly after, he signs the employment agreement, then the employment agreement may contain a clause confirming the parties will enter into the additional agreements. The additional agreements may also be added as exhibits to the employment agreement. For example, if the executive and employer will sign a change in control agreement when the executive joins the company, the employment agreement may provide the following: “The Company and the Executive shall enter into the Change in Control Agreement attached as Exhibit __ to this Agreement.” § .. no conflicting agreements clause The no conflicting agreements clause sets out the executive’s representation that no preexisting contracts prohibit him from entering into the employment agreement or CIIAA. The employer almost always inserts this clause in the employment agreement. Unless protection for the executive is separately negotiated, the employer may use this clause to justify terminating the executive in the event a former employer alleges a preexisting agreement (e.g., non-compete agreement) prevents the executive from working for the employer.64 The no conflicting agreements clause may also explicitly prohibit the executive from using intellectual property owned by former employers or others in his service to the employer. § .. non-solicitation of employees clause The non-solicitation of employees clause prohibits the executive, after employment, from soliciting a current employee of the ex-employer from leaving his employment. Generally, courts will enforce a non-solicitation of employees clause.65 The clause may be included in the employment agreement, although it is often found in the CIIAA.

63

Change in control agreements are discussed in § 8.1.1. Management carve-out agreements are discussed in § 8.1.2. 64 See § 10.5.3.3 for a discussion on protecting executives where non-compete agreements may be a concern. 65 Chicago Title Ins. Corp. v. Magnuson, 487 F.3d 985 (6th Cir. 2007); Overholt Crop Ins. Service Co. v. Travis, 941 F.2d 1361 (8th Cir. 1991); Belton v. Sigmon, 101 F. Supp. 2d 435, 443 (W.D. Va. 1998); Combined Ins. Co. of America v. Hansen, 756 F. Supp. 458 (D. Or. 1991); cf. MacGinnitie v. Hobbs Group, LLC, 420 F.3d 1234, 1242 (11th Cir. 2005) (clause prohibiting solicitation of former employer’s employees is overbroad for lack of a geographical or relationship restriction).


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§ .. non-compete clause The non-compete clause prohibits a former employee from competing against his employer, or one or more parts of the employer’s business, for a defined period of time in a defined geographic area. A non-compete clause in an employment agreement may contain the executive’s entire non-compete obligation, or it may reference a standalone non-compete agreement. Non-compete agreements are discussed in greater detail in Chapter 10. § .. severance and acceleration clauses — protecting the executive Typically, the executive best protects himself by negotiating his severance benefits before employment begins. Severance benefits included in the employment agreement become a contractual obligation of the employer after employment terminates. The executive’s goal is usually to maximize his protection in the event of a termination of employment without Cause or in the event the executive has “Good Reason” to resign (sometimes known as “constructive termination”). Protection for the executive often means that in the event the executive’s employment is terminated by the employer without Cause or by the executive for Good Reason, the employee will receive a cash payment, paid COBRA benefits, accelerated vesting of equity (stock options, restricted stock units, etc.), an extended post-termination exercise period for vested stock options, and perhaps payment of other benefits or perquisites.66 § 7.4.18.1 The Impact of § 409A on the Employment Agreement’s Severance Clause The American Jobs Creation Act of 2004 added § 409A to the Internal Revenue Code. The IRS explains: “Section 409A applies to compensation that workers earn in one year but that is not paid until a future year. This is referred to as nonqualified deferred compensation.”67 Section 409A does not apply to employer qualified plans such as 401(k) retirement plans68 nor to “any bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plan.”69 Section 409A’s implementing regulations are a 397-page morass.

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In back-end severance negotiations, departing employees sometimes request paid outplacement services (or money in lieu of outplacement services) and the right to keep a company-owned computer, cell phone. or other electronic device. 67 Internal Revenue Service, Frequently Asked Questions: Sec. 409A and Deferred Compensation, www.irs. gov/newsroom/article/0,id=172883,00.html (Aug. 7, 2007); see also 26 U.S.C. §§ 409A(a)(1)(A), 409A(d) (1)(A). Section 409A is relatively new, and there are a dearth of court cases interpreting the regulation. Consequently, there is risk the law may change abruptly vis-à-vis § 409A and its regulations. 68 Treas. Reg. § 1.409A-1(a)(2). 69 26 U.S.C. § 409A(d)(1)(B).

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The definition of non-qualified deferred compensation under § 409A is very broad.70 Employment agreements (with severance provisions), change in control agreements, separation agreements, deferred compensation plans, and deferred bonus or commission plans may cause an executive to earn deferred compensation under § 409A. The IRS explains: If deferred compensation covered by section 409A meets the requirements of section 409A, then section 409A has no effect on the employee’s taxes. The compensation is taxed in the same manner as it would be taxed if it were not covered by section 409A. If the arrangement does not meet the requirements of section 409A, the compensation is subject to certain additional taxes, including a 20% additional income tax.71 Interest may also be assessed on § 409A non-compliant deferred compensation, and the compensation is taxable as current income (probably the day of contracting for the non-qualified deferred income, not the day it is paid).72 The failure to include the nonqualified deferred compensation in current income may cause the IRS to assess nonpayment penalties, thereby increasing § 409A’s pain. Obviously, the solution is to write all executive and entrepreneur employment agreements so they are § 409A compliant. There are a number of different § 409A concerns that regularly affect the employment relationship. As discussed in § 7.4.6.6, § 409A’s onerous provisions will attach to those granted employee stock options or stock appreciation rights at exercise prices below fair market value. The solution: ensure that all stock options or SARS are granted at the fair market value of a share of the employer’s common stock on the date of grant. With respect to the severance clause in the executive’s employment agreement, § 409A provides important timing and process restrictions to ensure severance (and other) payments qualify as § 409A-compliant “deferred compensation” (or are excluded from § 409A taxation because the compensation is classified as non-deferred compensation). The regulations seek to eliminate both the executive’s ability to trigger the event causing the employer’s obligation to pay severance and his discretion to determine the timing of the severance payment. To be § 409A compliant, compensation (e.g., severance under an employment agreement or payments resulting from a change in control) must be subject to a substantial risk of forfeiture. “The rights of a person to compensation are subject to a substantial risk of forfeiture if such person’s rights to such compensation are conditioned upon the future performance of substantial services by any individual.”73

70

See 26 U.S.C. § 409A(d)(1). Internal Revenue Service, Frequently Asked Questions: Sec. 409A and Deferred Compensation, www.irs. gov/newsroom/article/0,id=172883,00.html (Aug. 7, 2007). 72 26 U.S.C. § 409A(a)(1)(A)–(B). 73 26 U.S.C. § 409A(d)(4). 71


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In essence, the compensation is “earned” when the substantial risk of forfeiture is removed. In addition, to be § 409A compliant, the deferred compensation (or compensation excluded from § 409’s rules because it is classified by § 409’s regulations as non-deferred compensation) may not be distributed earlier than one of the following events: the employee’s “separation from service”74; the date the employee is disabled75; the employee’s death76; “a specified time (or pursuant to a fixed schedule) specified under the plan at the date of the deferral of such compensation”77; • a corporate change in control78; • “the occurrence of an unforeseeable emergency.”79

• • • •

In addition to meeting the vesting (qualifying) provisions above, distributions must satisfy certain other requirements to be classified as non-deferred compensation under § 409A. For severance clauses in employment agreements, the two most important exemptions from § 409A are the “short-term” deferral exemption and the two-year, two-times-salary (capped) exemption. The “short-term” deferral exemption excludes from § 409A taxation compensation subject to a substantial risk of forfeiture, when the compensation is paid on or before two and one-half months of the year following the year in which the compensation is earned.80 The “year” in which the compensation is earned, for purposes of the shortterm deferral exemption, is either the employee’s tax year (almost always the calendar year) or the employer’s tax year.81 This two and one-half month exemption is a very powerful exemption because payments are not limited by amount and are not categorized as deferred compensation.82 Consequently, for employers and employees with a calendar tax year, severance payments required by an employment agreement to be paid on or before March 15th of

74

26 U.S.C. § 409A(a)(2)(A)(i). The Code provides that the secretary of the treasury shall define “separation from service,” which the Secretary has done at Treas. Reg. § 1.409A-1(n). 75 26 U.S.C. § 409A(a)(2)(A)(ii). The Code defines “disabled” at 26 U.S.C. § 409A(a)(2)(C). 76 26 U.S.C. § 409A(a)(2)(A)(iii). 77 26 U.S.C. § 409A(a)(2)(A)(iv). 78 26 U.S.C. § 409A(a)(2)(A)(v). The Code provides the secretary of the treasury with the authority to define the scope of a change in control. 79 26 U.S.C. § 409A(a)(2)(A)(vi). “Unforeseeable emergency” is defined at 26 U.S.C. § 409A(a)(2)(B)(ii)(I). Distributions pursuant to unforeseeable emergencies are limited. 26 U.S.C. § 409A(a)(2)(B)(ii)(II). 80 Treas. Reg. § 1.409A-1(b)(4). 81 Treas. Reg. § 1.409A-1(b)(4)(i)(A). 82 Treas. Reg. § 1.409A-1(b)(4).

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the year following a qualifying “separation from service” will not be subject to § 409A taxes.83 Also exempt from § 409A’s taxation provisions are severance payments that do not exceed two times the employee’s annual pay (up to a cap set by the IRS every year) providing that the severance is paid no later than December 31st of the second taxable year after the year in which the employee’s employment terminates (presuming the termination qualifies as a “separation from service,” and the employee’s taxable year is the calendar year).84 Section 409A’s regulations allow each severance payment to be designated as a separate payment, providing the separate payment requirement is set out in the employment agreement.85 This allows a series of payments to qualify for different exemptions. For example, the separate payments provision may be used to allow one payment to qualify for the short-term deferral exemption and another payment for the two-year, two-times-salary (capped) exemption. The separate payments provision can be used to identify § 409A compliant severance and § 409A non-compliant severance. Severance payments qualifying under the two exemptions discussed above must be payable solely on a “separation from service” to maintain their § 409A exemption. If the payments may be triggered for other reasons, the exemptions will not apply.86 The form of the payment, whether paid in lump sum or over time, should be described in the employment agreement and cannot be chosen (or changed) after employment terminates.87 An involuntary employment termination without Cause qualifies as a “separation from service” for § 409A purposes. Section 409A’s regulations provide: An involuntary separation from service means a separation from service due to the independent exercise of the unilateral authority of the [employer] to terminate the [employee’s] services, other than due to the [employee’s] implicit or explicit request, where the [employee] was willing and able to continue performing services . . . . The determination of whether a separation from service is involuntary is based on all the facts and circumstances.88

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Similarly, for employers and employees with calendar year tax years, bonus plans that provide that bonus payments shall be made by March 15th of the year following the year the bonus is earned will qualify for the short-term deferral exemption. The March 15th deadline must be revised to the appropriate date two and one-half months after the end of the employer’s tax year if the employer has a noncalendar tax year. 84 Treas. Reg. § 1.409A-1(b)(9)(iii)(B). 85 Treas. Reg. § 1.409A-1(m). 86 Treas. Reg. § 1.409A-1(b)(9)(iii). 87 26 U.S.C. § 409A(a)(4)(C); Treas. Reg. § 1.409A-2(a). 88 Treas. Reg. § 1.409A-1(n)(1). In this and other quotes from § 409A’s regulations, [employer] and [employee] are substituted for the terms “service provider” and “service recipient,” which are used in the regulations and whose scope is broader than employer and employee.


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Definition of Cause clauses are discussed in § 7.4.18.2. Beware: If the executive also controls the employer, the IRS might conclude that a substantial risk of forfeiture does not exist, regardless of the clauses contained in the employment agreement.89 This situation may occur, for example, when a founder enters into an employment agreement guaranteeing severance with the company in which he is the majority shareholder. However, the substantial risk of forfeiture probably would exist if the founder did not control the board and thus could not prevent himself from being fired. A termination of employment for “Good Reason” may qualify as an involuntary “separation from service” for purposes of excluding severance pay from § 409A taxes.90 Section 409A’s regulations seek to limit both the triggering events that define “Good Reason” and the timing of the severance triggered by a Good Reason clause. The regulations also limit the amount of the “Good Reason” severance payment to the amount paid on termination without Cause if severance is paid in this circumstance.91 Whether a termination of employment for “Good Reason” qualifies as a “separation from service” depends on “all the facts and circumstances.”92 The regulations contain a safe harbor definition of “Good Reason” for use in severance clauses.93 Good Reason clauses are discussed in § 7.4.18.3. In defining deferred compensation, § 409A also excludes reimbursements required by an employment agreement for business, moving, and outplacement expenses incurred by a departing employee after a “separation from service,” if the expenses would otherwise be tax-deductible by the employee.94 The ex-employee may incur these expenses until the end of the second taxable year after the taxable year of his separation from service.95 In addition, § 409A’s regulations contain a catchall clause, permitting an employment agreement to require an employer to reimburse a departing employee up to $15,000 of miscellaneous business expenses.96

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Treas. Reg. § 1.409A-1(b)(1) (if an employee effectively controls the behavior, effectively controls any portion of the compensation, or is a family member of the person having discretion over the employee’s compensation, “the discretion to reduce or eliminate the compensation will not be treated as having substantive significance”). 90 Treas. Reg. § 1.409A-1(n)(2). 91 Treas. Reg. § 1.409A-1(n)(2)(ii)(B). 92 Treas. Reg. § 1.409A-1(n)(1). 93 Treas. Reg. § 1.409A-1(n)(2)(ii). 94 Treas. Reg. § 1.409A-1(b)(9)(v)(A). In-kind benefits paid by the employer are not deferred compensation if the employee would have a right to reimbursement for payment of the in-kind benefit. Treas. Reg. § 1.409A-1(b)(9)(v)(C). Reimbursed expenses and in-kind benefits may “not constitute a substantial portion” of the employee’s “overall compensation received due to a separation from service.” Treas. Reg. 1.409A-1(c)(2)(i)(E). 95 Treas. Reg. § 1.409A-1(b)(9)(v)(E). Once the employee incurs the reimbursable expense, the employer must repay the expense “on or before the last day of the [employee’s] taxable year following the taxable year in which the expense was incurred.” Treas. Reg. 1.409A-3(i)(1)(iv)(A)(4). 96 Treas. Reg. § 1.409A-1(b)(9)(v)(D). The agreement requiring the reimbursement of post-separation expenses must provide an “objectively determinable nondiscretionary definition of the expenses eligible for reimbursement.” Treas. Reg. 1.409A-3(i)(1)(iv)(A)(1).

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A requirement that an executive sign a release as a precondition to receiving severance does not qualify as a “substantial risk of forfeiture” under § 409A. Consequently, an employment agreement requiring the execution of a release as a condition precedent to payment of severance (which almost all executive employment agreements include) should mandate that the release be executed and separation payments made within the time period of the exemption relied on. For example, an employment agreement that requires a release be entered into within 60 days of the termination of the executive’s employment, and further requires a lump sum severance payment be made on or before three days after the effective date of the release, will cause the separation payment to fall within the “short-term” deferral exemption (providing the release is effective eleven or fewer days after signing).97 Following is an example of a clause which does so: In the event that Executive’s employment is terminated by the Company without Cause or Executive resigns for Good Reason and providing that Executive’s termination of employment constitutes a “separation from service” within the meaning of Treasury Regulation § 1.409A-1(h) (“Separation”) and Executive executes within sixty (60) days following Executive’s Separation (“Deadline”) and does not revoke a general release of claims, negotiated in good faith between the parties (which release shall have certain reasonable carve-outs, such as a carveout for indemnification claims), then on or before the third calendar day after the release becomes effective, the Company shall . . . . § 7.4.18.2 Termination Without Cause Clause The termination without Cause clause in an employment contract provides that the executive will receive severance benefits in the event the employer terminates the executive without “Cause.” Thereafter, the employment agreement usually defines “Cause.” The narrower the definition of Cause, the more protected the executive. The broader the definition of Cause, the more protected the employer. Beware of employment contracts that do not define “Cause.” These contracts have two latent definition-related problems. First, they may lead to litigation after employment terminates, especially where the parties take diverse positions on what

97

See P. Garth Gartrell, The 409A Administration Handbook (5th ed. 2009 West) for a detailed analysis of § 409A. While Mr. Gartrell’s handbook is an excellent source for those desiring an explication of § 409A, only a § 409A-blinded author could write: “IRS [§ 409A] guidance to date has been fairly clear. . . .” Id. at 1. § 409A’s regulations can create numerous “traps” for the uninitiated. See, e.g., Daniel L. Hogans & Michael J. Collins, Internal Revenue Code Section 409A: Ten Traps for the Unwary, 8 Pension & Benefits Daily Report 4 (BNA 2008).


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“Cause” meant on the date the employment agreement was entered into.98 Second, the definition of “Cause” may default to a judicially or statutorily imposed definition, which may be a much more pro-employer definition than the parties would negotiate at the outset of employment. Following is an example of a “strong pro-executive” contractual definition of Cause: For purposes of this Agreement, “Cause” shall mean only the Executive’s: (i) willful, substantial, and repeated refusal to follow a lawful and reasonable directive of the Company’s Board; (ii) willful, substantial, and repeated gross neglect of his obligations to the Company which causes a material economic loss to the Company; or (iii) conviction of a felony crime involving moral turpitude. Executive shall not be terminated for Cause under (i) and (ii) above unless the Board delivers to the Executive a written statement identifying all the ways in which the Board believes Cause exists under (i) and/or (ii), as applicable, and Executive is given thirty days to cure, providing that if Executive cures, Cause shall not exist under (i) and/or (ii), as applicable. This definition is pro-executive because it severely limits the employer’s ability to terminate the executive for Cause. “Willful, substantial, and repeated” are very difficult standards to meet. “Material” damages must be proven. And the “conviction of a felony crime of moral turpitude” provision excludes a whole host of crimes, including misdemeanor crimes of moral turpitude. An example of a “strong pro-employer” definition of “Cause” follows: For purposes of this Agreement, “Cause” shall mean only: (i) Executive’s failure to perform the Executive’s assigned responsibilities, (ii) Executive’s engaging in any act of dishonesty, fraud, or misrepresentation, (iii) Executive’s violation of any federal or state law or regulation applicable to the business of the Company, or (iv) Executive’s breach of any agreement between the Executive and the Company, including without limitation, any breach of the confidential information and invention assignment agreement between the Executive and the Company. This clause is “pro-employer” because the definition of “Cause” is met by a wide array of executive conduct, including acts that most would consider misfeasance,

98

In Bowers v. Foto-Wear, Inc., the Court stated: I find that the meaning of ‘cause’ in the employment contract is reasonably susceptible to both parties’ interpretations. As suggested by [plaintiff ], the contract can be reasonably read to limit causes of termination to the situation listed . . . . On the other hand, the contract can also be reasonably read to incorporate common law reasons for terminating a for cause employment relationship. Bowers v. Foto-Wear, Inc., No. 3:CV-03-1137, 2007 WL 906417, at *5–6 (M.D. Pa. March 22, 2007).

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not malfeasance. For example, a non-performing but well-meaning and hardworking executive could be fired for Cause under subsection (i). § 7.4.18.3 Good Reason to Resign (Constructive Termination) Clause The Good Reason to Resign clause (sometimes called a constructive termination clause) in an employment contract sets out the conditions under which the executive may voluntarily terminate his employment and trigger severance, accelerated vesting, and/or other benefits. For example, most Good Reason clauses contain a trigger, providing that the executive may voluntarily terminate his employment and collect severance in the event the employer moves the executive’s principal place of employment some number of miles from his current place of employment. The broader the definition of “Good Reason,” the more the executive is protected. The narrower the definition of “Good Reason,” the more the employer is protected. Improperly drafted Good Reason clauses may cause the Good Reason benefits to be categorized as § 409A non-compliant deferred compensation, triggering § 409A taxes. With respect to the events that trigger Good Reason, § 409A’s regulations provide: Generally such conditions will be pre-specified under an agreement to provide compensation upon a separation from service for good reason. Such a good reason (or a similar condition) must be defined to require actions taken by the [employer] resulting in a material negative change to the [executive] in the service relationship, such as the duties to be performed, the conditions under which such duties are to be performed, or the compensation to be received for performing such services. Other factors taken into account in determining whether a separation from service for good reason effectively constitutes an involuntary separation from service include the extent to which the payments upon a separation from service for good reason are in the same amount and are to be made at the same time and in the same form as payments available upon an actual involuntary separation from service, and whether the [executive] is required to give the [employer] notice of the existence of the condition that would result in treatment as a separation from service for good reason and a reasonable opportunity to remedy the condition.99 Section 409A’s regulations contain a “Good Reason” safe harbor definition. The Good Reason safe harbor definition includes the following triggers for Good Reason: • “A material diminution in the [executive’s] base compensation.”100

99 100

Treas. Reg. § 1.409A-1(n)(2)(i). Treas. Reg. § 1.409A-1(n)(2)(ii)(A)(1).


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• “A material diminution in the [executive’s] authority, duties, or responsibilities.”101 • “A material diminution in the authority, duties, or responsibilities of the supervisor to whom the [executive] is required to report, including a requirement that a[n executive] report to a corporate officer or employee instead of reporting directly to the board of directors of a corporation (or similar governing body with respect to an entity other than a corporation).”102 • “A material diminution in the budget over which the [executive] retains authority.”103 • “A material change in the geographic location at which the [executive] must perform the services.”104 • “Any other action or inaction that constitutes a material breach by the [employer] of the agreement under which the [executive] provides services.”105 In addition, the safe harbor requires that: • The termination of employment occurs within two years “following the initial existence of one or more of the conditions arising without the consent of the [executive].”106 • “The amount, time, and form of payment upon the separation from service must be substantially identical to the amount, time, and form of payment payable due to an actual involuntary separation from service, to the extent such a right exists.”107 • The executive must advise the employer of the triggering Good Reason event within 90 days of the event and must provide at least 30 days for the employer to remedy the condition.108 The safe harbor Good Reason definition does not cover all circumstances that should legitimately be included in a Good Reason definition. Following is an example of a nonsafe harbor Good Reason clause: For purposes of this Agreement, “Good Reason” means any of the following are undertaken without the Executive’s express written consent: (i) a material

101

Treas. Reg. § 1.409A-1(n)(2)(ii)(A)(2). Treas. Reg. § 1.409A-1(n)(2)(ii)(A)(3). 103 Treas. Reg. § 1.409A-1(n)(2)(ii)(A)(4). 104 Treas. Reg. § 1.409A-1(n)(2)(ii)(A)(5). 105 Treas. Reg. § 1.409A-1(n)(2)(ii)(A)(6). 106 Treas. Reg. § 1.409A-1(n)(2)(ii)(A). 107 Treas. Reg. § 1.409A-1(n)(2)(ii)(B). 108 Treas. Reg. § 1.409A-1(n)(2)(ii)(C). 102

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reduction in the Executive’s duties, authority, or responsibilities; (ii) the Executive ceasing to report to the Board; (iii) a material reduction at any time of the Executive’s base salary or bonus potential, other than in conjunction with a reduction in salaries or bonus potential affecting all officers of the Company, providing that the percentage of reduction in Executive’s base salary and bonus potential shall be no larger than the percentage reduction of the officer of the Company receiving the least reduction in base salary and bonus potential; (iv) a material relocation of the Executive’s principal place of employment to an office located more than thirty-five (35) miles (measured by road travel) from the location of the Executive’s principal place of employment on his first day of employment; (v) a material breach by the Company of any provision of this Agreement or any equity or compensation agreement between the Executive and the Company; (vi) any attempt by the Company or any successor-in-interest to the Company to reduce or cancel any of Executive’s stock options or restricted stock units; or (vii) any failure by the Company to obtain the assumption of this Agreement by any successor-in-interest of the Company. However, none of the foregoing events or conditions shall constitute Good Reason for the Executive to resign his employment unless: (A) the Executive provides the Company notice of the event or events giving rise to Good Reason within ninety (90) days of the occurrence of the event or events; (B) the Executive provides the Company at least thirty (30) days to cure the situation; (C) the Company does not cure within the time period provided by the Executive under (B); and (D) the Executive terminates his employment within two years of the first event giving rise to the occurrence of Good Reason.

§ 7.4.18.4 Specified Employee Clause Certain senior executives of public employers are classified as “specified employees” under § 409A.109 Section 409A’s regulations contain alternative definitions of “specified employees,” but generally specified employees include employees of publicly traded employers who, as of the date of their separation from service: (a) are corporate officers earning more than $130,000/year; (b) own at least five percent of their employer; or (c) own at least one percent of their employer and earn more than $150,000/year.110 Under certain circumstances, “specified employees” must wait at least six months and one day after the termination of their employment to receive their severance benefits.111 Section 409A’s regulations require that the six-month delay requirement be specifically incorporated into the employment agreement of any executive who

109

26 U.S.C. § 409A(a)(2)(B)(i). Id.; 26 U.S.C. 26 U.S.C. § 416(i)(1)(A); Treas. Reg. § 1.409A-1(i)(1). 111 26 U.S.C. § 409A(a)(2)(B)(i). Severance pay that qualifies under the short-term deferral exemption is not subject to the six-month deferral requirement. 110


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wishes to delay payment to conform with § 409A.112 The following clause is an example of one that may be added to an executive’s agreement to address this requirement: Notwithstanding any other term in this Agreement, if, at the time of Executive’s “separation from service” within the meaning of Treasury Regulation § 1.409A1(h) (“Separation”), Executive is a “specified employee,” as defined in Treasury Regulation § 1.409A-1(i), to the extent delayed commencement of any portion of the benefits to which Executive is entitled under this Agreement is required in order to avoid a prohibited distribution under 26 U.S.C. § 409A(a)(2)(B)(i), that portion of Executive’s benefits shall not be provided to Executive before the earlier of (a) six (6) months and one day after Executive’s Separation from the Company, or (b) the date of Executive’s death. All payments deferred pursuant to this section shall be paid in a lump sum to the Executive on the date which is six months and one day after Executive’s Separation, or the date of Executive’s death, as applicable, and any remaining payments due under this Agreement shall be paid as required by this Agreement. The “specified employees” rule does not apply to private company executives.113 Nevertheless, because all public company executives may one day qualify as a specified employee (even if they do not qualify on the first day of their employment) and because all private employer executives may one day find themselves specified employees of their newly public employer, the § 409A six-month delay clause should be included in every executive employment agreement. § 7.4.18.5 Single Trigger vs. Double Trigger Protection The executive usually seeks to negotiate for protection in the event the employer terminates him without Cause, or he has Good Reason to resign without regard to any other company event. A termination without Cause or termination with Good Reason severance clause in an employment contract that provides benefits independent of any other corporate event is usually referred to as a “single trigger” severance clause. Many employers contend that the executive should not receive severance protection unless the employer has undergone a change in corporate control. They offer termination without Cause and Good Reason to resign provisions triggered only after the employer experiences a corporate change in control. These clauses are typically referred to as “double trigger” severance clauses. The first trigger is the occurrence of the change in control, and the second trigger is the occurrence of the termination of employment by the employer without Cause or by the employee for Good Reason.

112 113

Treas. Reg. § 1.409A-1(c)(3)(v). 26 U.S.C. § 409A(a)(2)(B)(i).

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Sometimes the parties agree on different levels of protection, depending on whether or not a change in corporate control has occurred. For example, an employment contract might provide the executive with a lump sum payment equivalent to six months of base salary in the event the employer terminates the executive’s employment without Cause before a change in control, but a lump sum payment of 12 months of base salary if the employer terminates the executive’s employment on or after a change in control. § 7.4.18.6 Post-Termination Benefits § 7.4.18.6.1 Severance Pay The employment contract acting as a severance agreement usually contains a clause setting out the payments and benefits that occur when the employer terminates the executive’s employment without Cause, or the executive resigns his employment for Good Reason. Severance pay may be stated as a simple dollar amount (e.g., a $50,000 payment). It may be expressed in number of months of base salary (e.g., six months base salary). It may include payment of target bonuses or other expected compensation. It may be paid in one lump sum or over time. It is subject to legally required withholding taxes and should be § 409A compliant. The amount of severance pay an executive may command will depend on a multitude of factors, including the executive’s experience and the employer’s market, size, location, stage of development, prior history, and so forth.114 It is important to understand these factors at the outset of the employment negotiation because severance may be an important part of the overall negotiation. § 7.4.18.6.2 COBRA/Medical Benefits The employment contract acting as a severance agreement frequently contains a COBRA/medical benefits clause. This clause describes the COBRA or state-equivalent benefits the employer will provide on behalf of the departing employee. According to the U.S. Department of Labor: [COBRA] gives workers and their families who lose their health benefits the right to choose to continue group health benefits provided by their group health plan for limited periods of time under certain circumstances such as voluntary or involuntary job loss . . . . ***

114

The U.S. Bankruptcy Code restricts severance payments to “insider” executives of companies in bankruptcy. 11 U.S.C. §503(c)(2). Severance payments to insider executives must be part of a severance program generally available to all full-time employees and may not be greater than 10 times the average severance payment paid to non-management employees in the same year. Id. “Insiders” under the Bankruptcy Code include directors, officers, and persons in control of debtor corporations. 11 U.S.C. § 101(31)(B).


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COBRA generally requires that group health plans sponsored by employers with 20 or more employees in the prior year offer employees and their families the opportunity for a temporary extension of health coverage (called continuation coverage) in certain instances where coverage under the plan would otherwise end.115 Employers frequently provide COBRA benefits for their departing executives for the same number of months as they pay severance. For example, the employer providing six months of severance pay will often provide six months of paid COBRA benefits. This is not written in stone, however. Sometimes COBRA benefits are provided for shorter or longer periods or not at all. Regardless of whether the employer agrees to pay for COBRA benefits and how the benefits are paid, the employee must timely elect COBRA benefits to receive them. One § 409A regulation specifically exempts from § 409A taxation COBRA benefits paid as reimbursements to the executive for COBRA premiums paid by the executive during the COBRA coverage period.116 A separate § 409A regulation provides that medical benefits that are non-taxable because they are part of an Internal Revenue Code qualifying employer medical plan (most employer medical plans) are also exempt from § 409A.117 COBRA benefits paid directly by the employer to the COBRA administrator, or, if the employer acts as its own COBRA administrator, paid directly by the employer to the insurance carrier, should, in most cases, be § 409A compliant under this regulation. An example of a COBRA reimbursement clause falling within the specific § 409A exemption discussed above is: “The Company shall reimburse Executive for six months of COBRA premium payments paid by the Executive (and not reimbursed by any third party), providing Executive timely elects COBRA coverage.” An example of a direct premium pay COBRA clause, which should also be § 409A compliant, follows: “The Company shall pay six months of the Executive’s COBRA premiums directly to the COBRA administrator, providing Executive timely elects COBRA coverage.” § 7.4.18.6.3 Equity Acceleration Equity acceleration clauses provide that the vesting of an executive’s equity accelerates when the employer terminates his employment without Cause, or the executive resigns for Good Reason. Equity grants are frequently the place where executives accrue great wealth; consequently, the negotiation of equity acceleration severance clauses may take time during employment negotiations.

115

U.S. Dep’t of Labor, Continuation of Health Coverage—COBRA, www.dol.gov/dol/topic/health-plans/ cobra.htm. 116 Treas. Reg. § 1.409A-1(b)(9)(v)(B). Reimbursement of COBRA premium payments made by the executive will be § 409A compliant because the COBRA reimbursements are not considered deferred compensation. Id. 117 Treas. Reg. § 1.409A-1(a)(5). The plan’s medical benefits must be non-taxable under 26 U.S.C. §§ 105–106.

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Unprotected equity that has not vested by the executive’s employment termination date will often be lost. For example, an executive may have an option to exercise 100,000 shares of an employer’s stock vesting over the next two years, which is in the money by $50/share (every share is worth $50 to the executive because the spread between the stock price and the option exercise price is $50). If the employer’s stock price does not move over the next two years, and the executive remains employed for these two years, the option will be worth $5,000,000. However, if the executive’s employment terminates, and the executive’s equity is unprotected, the executive loses the $5,000,000 in potential (contingent) earnings. Because of the importance of equity to many executives’ employment decisions, executives frequently seek full vesting of their unvested equity in the event that their employment is terminated without Cause by the employer or for Good Reason by them. From the executive’s perspective, he should receive the fruits of his labor, particularly if he has been responsible for the growth of the employer. He should not suffer a loss of equity simply because the employer decides to fire him for reasons that may be less than clear or even economically irrational. By contrast, the employer may begin an employment negotiation offering no accelerated vesting on termination of employment. From the employer’s perspective, the greater the accelerated vesting, the less incentive the executive has to work hard. Furthermore, from the employer’s perspective, accelerated vesting is tantamount to an unearned windfall. Stock vests just as a right to wages vests, and there is no right to additional equity, from the employer’s point of view, unless the executive works through the equity vesting dates. The amount of vesting acceleration may differ depending on whether the executive’s employment is a single or double trigger termination. For example, an executive might receive one year’s accelerated vesting of all stock options and RSUs in the event of an involuntary employment termination without Cause before a corporate change in control, but 100 percent accelerated vesting of stock options and RSUs if the involuntary termination without Cause occurs on or after a change in control. Sometimes, the equity acceleration clause is triggered only by a change in control. Some employers provide for partial (or full) vesting acceleration of all employees’ stock options in the event the company is sold. Equity plan documents and stock option agreements may provide that employee stock options are cancelable by an acquirer that refuses to assume the stock options after an acquisition. If this occurs, and the employee has no equity protection against this possibility, the employee would lose all shares not vested by the day the acquisition closes. The solution: A provision fully accelerating all options in the event an acquirer refuses to assume the target’s employee stock options. § 7.4.18.6.4 Post-Termination Exercise Period Extensions An extended post-termination exercise period for their employee stock options is one of the most important “asks” executives overlook when they first consider their employment negotiation. The employment agreement’s (or stock option agreement’s) post-termination


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exercise clause provides the length of time after the executive’s last day of employment that the executive has to exercise his vested employee stock options. Without an extended post-termination exercise clause, many employee stock options expire on or within 90 days after the final date of employment.118 Even though an employer may have a “standard” post-termination exercise period (or no posttermination exercise period), the employer’s equity plan119 probably allows its board of directors discretion to grant extended post-termination exercise periods. A one-year extended post-termination exercise period clause might read, “In the event Executive’s employment with the Company terminates, then all of Executive’s vested employee stock options shall be exercisable, in whole or in part, at any time up to and including the one year anniversary of the last day of Executive’s employment.” Sometimes, an employer will agree to provide an extended post-termination exercise period to an executive who voluntarily terminates his employment (without Good Reason). Significantly more common, however, is the extended post-termination exercise period that kicks in if the executive’s employment terminates without Cause or for Good Reason. Stock options that expire on the last day of employment are particularly nefarious. An executive whose employment is terminated at 4:00 in the afternoon (a typical time to terminate an employee’s employment) will have very limited or no ability to exercise his vested stock options, leaving the executive with potentially a huge loss. An extended post-termination exercise period in this circumstance is critical because it allows the fired executive time to exercise his stock options and prevents gaming in the timing of the delivery of the employment termination notice. A post-termination exercise period extension of a year or more may be very valuable to the fired executive because the extension essentially turns the employee stock option into a long-term call on the ex-employer’s stock. Fired executives of private companies may find the extended post-termination exercise period particularly valuable because they are sometimes hesitant to pay the money necessary to exercise their stock options. This hesitation arises from the doubt they have about the ability of their replacements to build their former companies. The extended post-termination exercise period gives the executive time to determine whether his ex-employer will succeed under new management. § 7.4.18.6.5 Anti-Blackout Clause An anti-blackout clause extends the executive’s post-termination exercise period in the event that a public employer is unwilling or unable to deliver freely tradable stock to the executive when he exercises his employee stock option. An anti-blackout clause also extends the executive’s post-termination exercise period in the event the employer

118

It is important for the executive to know the last day he may exercise his vested options. Otherwise, valuable vested options may expire unexercised. It has happened. 119 See § 4.4.5.

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delivers freely tradable stock to the executive when he exercises his employee stock option, but the executive cannot sell the stock on the public market. This critical anti-blackout protective clause is as important for executives joining a private employer as those joining a public employer because the private employer may go public, invariably subjecting the executive to a lockup120 when he cannot sell his stock. During his post-termination exercise period, the executive who worked for a public company may not be able to exercise his employee stock options because the ex-employer is legally unable to deliver freely tradable stock to the executive. When a public company employee exercises an employee stock option, the company is able to deliver freely tradable stock to the employee because the company has registered the stock for public sale in its S-8 shelf registration statement.121 If the S-8 shelf registration statement is stale, the employer cannot legally issue registered stock from the S-8 to the employee option holder.122 An S-8 may become stale when the employer is not current on its SEC financial reporting obligations (because the employer has failed to timely file required financial statements with the SEC). When this occurs, the employer invariably points to a clause in the employee stock option agreement absolving the employer of the obligation to issue stock to the employee when it is illegal for the employer to do so. If the S-8 remains stale for the employee’s entire post-termination exercise period, the employee will be unable to exercise his employee stock options, and the options will expire unexercised.123 During the post-termination exercise period, the executive may be able to exercise his employee stock options but not sell the stock delivered after the exercise. This happens when the executive is in possession of material non-public information about the exemployer and thus is prohibited by federal law from selling stock on the public market.124

120

“Lockup” is the term usually given to the period of time after a company’s initial public offering when the employee cannot sell company stock on the public market because the employee has contractually agreed to refrain from all transactions in the company’s securities (except exercising employee stock options). Most employee stock option agreements contain a “lockup clause” that, at the request of the company’s underwriter (the investment bank retained to assist the company in selling its shares in the initial public offering), prohibits the employee from selling his company stock for a period not to exceed approximately 180 days after the initial public offering. Lockups are essentially contractually imposed blackouts (on selling stock). 121 17 C.F.R. §§ 230.428, 239.16b. 122 15 U.S.C. §§ 78l, 78m; 17 C.F.R. §§ 230.428, 239.16b. 123 In recent years, some employers have added automatic post-termination exercise extension clauses to their equity plans to cover situations where the employer is unwilling or unable to issue stock when an ex-employee attempts to exercise his stock option. 124 This situation may occur, for example, if the executive leaves the day the employer begins serious negotiations to sell the company. Under federal securities law, it is illegal for an employee (or ex-employee) to sell stock on the public markets when he is in possession of material non-public information about the ex-employer unless he contemporaneously discloses the material non-public information in his possession. 15 U.S.C. § 78(j); Chiarella v. U.S., 445 U.S. 222 (1980); Dirks v. SEC., 463 U.S. 646 (1983); SEC. v. Texas Gulf Sulfur Co., 401 F.2d 833 (2d Cir. 1968); U.S. v. Teicher, 987 F.2d 112 (2d Cir. 1993); 17 C.F.R. § 240.10b-5; Selective Disclosure and Insider Trading, Securities Act Release No. 33–7881 (Aug. 15, 2000), available at www.sec.gov/rules/final/33–7881.htm. Disclosing material non-public information


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Most public companies permit their employees to exercise their stock options and sell the exercised stock on the same day. This is commonly known as a “cashless exercise,” “flipping” the stock, or a “same-day exercise and sale.”125 In a same-day exercise and sale transaction, money earned from selling the stock on the public market is used to pay the option exercise price for the stock and to pay required withholding taxes. The employee takes home the difference between the option exercise price and the price at which the stock was sold (less withholding deductions). The ability to do a same-day exercise and sale is often critical to the executive because the option exercise price may be sufficiently high that the executive cannot afford to exercise his stock option without selling the exercised stock to pay for the sale. Even where the executive may be able to raise the funds needed to exercise the stock option, the risk of holding the purchased stock may be too high. Take, for example, the fired executive who is in possession of material non-public information about his ex-employer and who has 30 days to exercise a fully vested 100,000-share non-qualified employee stock option with an exercise price of $50/ share, where the stock is trading at $100/share. The executive must pay $5 million to exercise the option and hold the stock purchased on the exercise. If the executive raises the $5 million and exercises the option, the option exercise is a taxable event, and tax will be assessed on the $5 million gain (the spread). If the stock falls to $50/share before the material non-public information becomes public, the executive may sell his stock for $5 million, thus earning nothing for the stock, but he will be on the hook for taxes on the $5 million spread at the time of exercise. If the executive in this example had negotiated a simple anti-blackout clause that permitted him to exercise his stock option for 30 days after he was first legally able to sell company stock on the public market, then the executive would not have had to exercise his option when he was unable to sell stock. Thus, he could have avoided a potentially significant tax burden. Unfortunately, a simple anti-blackout clause will not sufficiently protect the executive in a situation where the employer’s stock price declines significantly during a blackout. In this circumstance, the risk of loss is reduced, but not eliminated, by an extended post-termination exercise period which may be tacked on to an anti-blackout clause extension.

about an employer at the time of a stock sale, however, is rarely an option for the executive because doing so almost always violates the confidentiality agreement the executive signed with his employer. Exercising an employee stock option (but not selling the stock received upon the exercise) when the executive is in possession of material non-public information should not constitute securities fraud. Cardinal Health Inc. Sec. Litig., 426 F. Supp. 2d 688, 730 (S.D. Ohio 2006) (“most courts do not view an executive’s decision to exercise his stock options before they expire as evidence of fraudulent insider trading”). 125 Federal Reserve Board Regulation T, 12 C.F.R. § 220.3(e)(4), governs cashless exercises of employee stock options.

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Take for example the executive who is fired during a company-wide blackout caused by the employer’s failure to file timely financial statements with the SEC and who has 30 days to exercise a 100,000-share fully vested stock option with an exercise price of $50/share where the stock is trading at $100/share. If the employer fails to file a corrective financial restatement until the one-year anniversary of the termination of the executive’s employment, then through no fault of his own (assuming the executive had nothing to do with the ex-employer’s financial misconduct), the executive will be unable to sell his company stock for one year. If, during this time, the stock price drops to $50/share, then his 100,000 share stock option is worthless. The stock price will probably not recover significantly in the 30 days post-blackout. But if the executive had negotiated a one year post-termination exercise period which could be tacked on to the end of a blackout period, then the executive would have one year post-blackout to see whether the ex-employer’s stock price recovers. § 7.4.18.6.6 Death and Disability An employment agreement may contain a clause that provides for benefits in the event the executive dies or is disabled. Some mature and public employers will purchase special insurance policies for their executives. On the other hand, venture capital–backed private companies rarely purchase insurance policies for their executives. Interestingly, while ready to ask for and accept all available benefits, many executives do not consider death and disability benefits a top priority. § .. the release and timing of negotiating the release The prospective employer will probably draft the initial employment agreement with a provision that severance and acceleration benefits are subject to the executive entering into the employer’s “standard release agreement” or a “general release of claims acceptable to the company” or similar language. Frequently the release is a one-way release under which the executive releases the ex-employer, and usually a host of related persons and entities, from all known and unknown claims, which ever existed or may exist from the beginning of time until the date the release is signed. The release also typically covers post-signing claims arising from acts or omissions that occurred before the signing of the release. However, the release will not release the employer from acts or omissions committed after the release is signed. The executive is often better off with a mutual release, pursuant to which the employer releases the executive just as the executive has released the employer. However, at the start of the employment relationship, most employers steadfastly refuse to agree to provide the departing executive with a mutual release of claims.126

126

There are many reasons for this hesitancy, including the employer’s unwillingness to consent to sign a future agreement that might release the executive from wrongdoing committed against the company


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When to negotiate the terms of the release is a judgment call. Faced with a contingent release requirement in a draft employment agreement, the executive has four choices: • Negotiate the terms of the release while the employment agreement is being negotiated, and thereafter attach the negotiated release as an exhibit to the employment agreement. • Add a statement to the employment agreement providing that the release will be mutually agreed on after good faith negotiations. • Add a statement to the employment agreement providing that good faith carve-outs will modify the employer’s “standard release,” perhaps listing some of the carve-outs.127 • Do nothing, and accept the employer’s standard release. The first three choices are strongly preferred from the perspective of protecting the executive against inadvertently waiving a right he may later consider important. The first and fourth choices may be preferable from a § 409A compliance perspective, in the sense that there is no doubt the applicable release will be signed by the signing deadline described in the employment agreement. Where an employment agreement requires good faith negotiations regarding the release, a clause must be added to the agreement requiring that negotiations conclude, and the parties sign the agreement in the applicable § 409A compliance period.128 The fourth choice creates risk for the executive, especially if the executive’s exit is rancorous, and the employer decides to play hardball. In a hardball situation, the employer may require the executive to choose between “disputed” employee benefits and separation benefits. If the executive signs the release to secure his contractual separation benefits, he may sacrifice the “disputed” employee benefits. On the other hand, if the executive refuses to sign the release, he may forfeit the separation benefits. Which approach to choose may depend on where the executive finds himself in the life cycle of his negotiation. § 7.4.19.1 Carve-Outs From the Release To protect the executive, carve-outs should be added to the employer-provided release (or referenced in the employment agreement). The substantive thrust of the carve-outs suggested below should not be objectionable to the employer, either because they do

(e.g., misappropriating the employer’s intellectual property). If the executive files a lawsuit after his employment terminates and then settles, the parties almost always enter into mutual releases, but the executive who departs with a severance negotiated at the outset of employment usually will not receive a mutual release. 127 See § 7.4.19.1 for a discussion of carve-outs from the release. 128 In addition, § 409A severance pay exemptions must be considered. See § 7.4.18.1.

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not affect core areas of employer concern, or they restate the law. However, the employer’s counsel may wish to tinker with the language. Carve-out language includes: • The release does not release obligations arising out of the release129; • The release does not release executive’s right to indemnification to the fullest extent provided for in any contract, corporate document, statute; or otherwise130; • The release does not release executive’s rights in and to any company insurance policy, including without limitation, any right to coverage, indemnification, or defense under any applicable policy; • The release does not release executive’s right to file for or receive unemployment insurance benefits131; • The release does not release executive’s right to any vested employee benefit (e.g., distribution from employee’s 401(k)) to the fullest extent provided for in any employee benefit plan; and • The release does not release executive’s right in and to his company equity, including without limitation, the right to exercise vested employee stock options and the right to hold and sell company equity owned by executive. Under various federal and state laws, employees cannot legally waive certain rights via a privately negotiated general release. For example, under federal law, an executive cannot release his right to vested 401(k) retirement benefits or his right to roll over his 401(k) balance into a later employer’s 401(k) plan.132 As another example, under California law, an employee cannot waive his statutory (as opposed to his contractual) right to indemnification.133 Nevertheless, given the rigorous enforceability of releases in most jurisdictions, it is better to add a clause to the release that restates the law so that business decision makers will have complete certainty about matters not released, and the employer cannot legitimately argue for a change in the law should the executive’s departure turn nasty.

129

It is not clear how one can release obligations arising out of the contract containing the release because the obligations are part of the consideration for the release. Nevertheless, the clause is common in release agreements, and no one ever objects to the clause. 130 Even where there is a statutory right to indemnification, the executive may release his contractual right to indemnification, which the executive would not want to do. 131 The right to apply for unemployment insurance cannot be waived in many jurisdictions. See, e.g., Cal. Unemp. Ins. Code § 1342; Fla. Stat. § 443.051; La. Rev. Stat. Ann. § 23:1693; Mass. Gen. Laws. ch. 151A, §§ 35–36; Mo. Rev. Stat. § 288.380; N.Y. Lab. Law § 595; Tex. Lab. Code §§ 207.071–074. 132 26 U.S.C. § 401(a)(13), (a)(31), (k)(13)(D)(iii). 133 Cal. Lab. Code §§ 2800, 2802, 2804; Edwards v. Arthur Andersen, 189 P.3d 285, 297 (Cal. 2008).


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§ 7.4.19.2 California Civil Code § 1542 California Civil Code § 1542 provides that a general release does not release material claims that the releasing party does not know about. § 1542 provides: A general release does not extend to claims which the creditor does not know or suspect to exist in his or her favor at the time of executing the release, which if known by him or her must have materially affected his or her settlement with the debtor.134 Every release agreement in California contains a § 1542 waiver. Typically, the waiver clause quotes § 1542 and thereafter provides that the executive, being fully aware of the statute, waives the protection it and any other similar state statutes provide. § .. § a clause Employment agreements often contain a “catch-all” § 409A clause providing that the contract shall be interpreted to comply with the requirements of I.R.C. § 409A, and, if necessary, the parties will work in good faith to amend the agreement to comply with § 409A.135 While this clause states the general intent of the parties, specific references to key § 409A provisions should (and in some cases, must) be included in the employment agreement. The § 409A clause may contain many additional provisions, especially with respect to severance and change in control benefits. The impact of § 409A on the employment agreement’s severance clause is discussed in § 7.4.18.1. § .. § g clause I.R.C. § 280G and § 4999 impose a 20 percent excise tax on parachute payments received in connection with a corporate change in control.136 In addition, the employer cannot deduct parachute payments as an expense.137 Parachute payments are change in control benefits with a value of three or more times the base amount of the employee’s average earnings over the previous five years.138 Change in control benefits include the value of all consideration received

134

Cal. Civ. Code § 1542. I.R.S. Bulletin 2010–3 (Jan. 19, 2010), available at http://www.irs.gov/pub/irs-irbs/irb10–03.pdf, provides guidance on revising defective deferred compensation plan documents. 136 26 U.S.C. §§ 280G(b)(2), 4999. Change in control agreements are discussed in §§ 4.6, 7.4.18.5, 8.1.1. 137 26 U.S.C., § 280G(a). 138 26 U.S.C. §§ 280G(b)(2)(A)(ii); Treas. Reg. § 1.280G-1, Q&A 13, 30, 34. 135

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because of the change in control, including the value of accelerated equity vesting and severance payments.139 The parachute payment rules contain a one-year “look-back” provision, meaning that payments made to the executive up to one year before the change in control may be categorized as parachute payments.140 However, compensation and equity payments made in the ordinary course of the employment relationship are excluded from the parachute payment calculation.141 Calculating the employee’s five-year average base earnings and the value of the change in control severance benefits can be a complex task. This is, in part, because the valuation of unvested but accelerating equity in change in control scenarios involves assumptions and specific calculations.142 These calculations are usually best left to accountants, consultants, or tax attorneys with experience in 280G valuations.143 If the change in control benefits are a multiple of three or more of the employee’s base earnings amount, the parachute payment triggers a 20 percent excise tax pursuant to I.R.C. § 4999.144 The 20 percent excise tax is applied to all change in control benefits in excess of one times (100 percent of) the base earnings value.145 One possible result of this taxing scheme is, in certain circumstances, to cause an executive’s take-home pay to increase as the executive’s income declines (or the executive’s take-home pay to decrease as the executive’s income increases). For example, if change in control benefits are a multiple of 2.99 of the employee’s base earnings, no excise tax will apply to any of the 2.99 multiple in earnings, but if change in control benefits increase another .01 percent (3 times base earnings), the 20 percent excise tax will apply to all benefits received in excess of one times the employee’s base earnings. Consequently, the executive may be better off, after taxes, by receiving less in change in control earnings. Executive employment agreements and change in control agreements frequently include a provision requiring the employer to pay the executive that sum which will result in the highest amount of take-home pay in the event compensation required by the applicable agreement triggers § 280G’s parachute payment provisions. Bad changes in control clauses, from the employee’s perspective, are those that cap change in control benefits at 2.99 times base earnings. These clauses may cause the employee to forfeit significant benefits (if equity is accelerated, the clause may have the effect of causing the forfeiture of equity), while, at the same time, ensuring the employer may deduct all of the benefits provided. Unless the parachute payments fall into the territory where less is more, the employee is better off paying a 20 percent excise tax on the parachute payment than not receiving the earnings.

139

26 U.S.C. § 280G(b)(2); Treas. Reg. § 1.280G-1, Q&A 22. 26 U.S.C. § 280G(b)(2)(C); Treas. Reg. § 1.280G-1, Q&A 22, 25. 141 26 U.S.C. § 280G(b)(1); Treas. Reg. § 1.280G-1, Q&A 9. 142 See, for example, Treas. Reg. § 1.280G-1, Q&A 24. 143 See discussion in § 3.3.4. 144 26 U.S.C. §§ 280G(b)(2), 4999. 145 26 U.S.C. § 280G(b)(4); Treas. Reg. § 1.280G-1, Q&A 30. 140


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Executives with significant leverage may sometimes negotiate a gross-up tax clause requiring the employer to gross-up all parachute payment excise taxes so that the executive’s take-home pay, after the gross-up, is the same as the executive would have taken home had the excise tax not been imposed. Gross-up provisions can be very expensive for the employer. At public companies, parachute payment tax gross-ups have been under attack, including by the leading third-party advisor of institutional holders of corporate stock.146 Consequently, there are essentially four ways to treat parachute payments in the employment or change in control agreement: • The agreement contains no § 280G clause (the agreement is silent on the issue). • The agreement provides the executive will receive only those payments that do not trigger § 280G and § 4999’s tax provisions (very bad for the executive). • The agreement provides the executive will receive the payout that results in the highest amount of take-home pay (post-tax income) for the executive (acceptable to the executive but not nearly as beneficial as the next clause). • The agreement provides that the employer will gross-up some or all payments subject to § 280G and § 4999 so that the executive receives the amount of takehome pay he would have received had his payments not been subject to the parachute payment’s excise tax provisions (great clause for executive; potentially very expensive for the employer). § .. assignment clause The employment agreement’s assignment clause states whether the employment agreement is assignable, and if it is, to whom or what it is assignable. Employers prefer that the clause confirm their ability to freely assign the agreement. The clause almost always allows the employer to assign the employment agreement to its successor-ininterest. From the executive’s perspective, the employment agreement should limit the employer’s ability to assign the contract to an affiliated company for whom he would be willing to work, or an acquirer. Employment agreements are usually not assignable by the executive because they are personal service contracts.147

146

Institutional Shareholder Services Inc., 2010 Compensation FAQs (Feb. 18, 2010) (Click on “Under RMG’s Executive Compensation Evaluation policy, which specific pay practices are considered most problematic and could result in a withhold/against recommendation regardless of other factors?”) available at www.issgovernance.com/policy/2010_compensation_FAQ. 147 The need for and effect of an employment agreement’s assignment clause is a function of state law. See, e.g., Sogeti USA LLC v. Scariano, 606 F.Supp.2d 1080, 1087 (D. Ariz. 2009) (Arizona law permits assignment of employment agreement where employment agreement silent on right to assign); Phoenix Capital, Inc. v. Dowell, 176 P.3d 835, 845 (Colo. Ct. App. 2007) (phrase “[this a]greement . . . shall inure to the benefit of the parties, and [the employer’s] successors and assigns” suffices to make assignable an otherwise not assignable personal services contract); Corporate Express Office Products, Inc. v. Phillips, 847 So.2d 406 (Fla. 2003) (consent to assignment of employment contract to prospective

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§ .. severability clause The employment agreement’s severability clause describes what happens if a court or arbitrator rules that one or more of the clauses in the employment agreement are illegal or unenforceable. Most employment agreements provide that invalidation of one clause does not affect any of the other terms of the employment agreement. Some employment agreements provide that the offending clause will be removed in its entirety. Others provide that the court or arbitrator should revise the offending clause so that the revised (and now enforceable) clause best reflects the original intent of the parties.148 § .. amendment clause An employment agreement’s amendment clause almost always states that amendments to the contract must be in writing and signed by the parties. The clause may also require that written amendments specifically mention the underlying employment contract or be executed by a senior officer of the employer (e.g., the CEO).149

employer required when prospective employer purchases corporate assets of old employer, but not when new employer results from a merger or purchase of 100 percent of outstanding stock); Wien & Malkin LLP v. Helmsley-Spear, Inc., 846 N.E.2d 1201, 1207–08 (N.Y. Ct. App. 2006) (personal services contracts generally not assignable without the principal’s consent). 148 Even though a contract’s severability clause may empower a court to revise (blue pencil) an unenforceable clause to make it enforceable, courts differ on their willingness to do so. Compare IKON Office Solutions, Inc. v. Dale, 22 Fed.Appx. 647, 648 (8th Cir. 2001) (blue penciling non-compete agreement to reduce duration and scope of non-compete obligation permissible under Minnesota law); Bristol Window and Door, Inc. v. Hoogenstyn, 650 N.W.2d 670 (Mich. Ct. App. 2002) (applying statute permitting courts to limit agreements so they are reasonable); Community Hospital Group, Inc. v. More, 838 A.2d 472, 485 (N.J. Super. Ct. App. Div. 2003) (courts may modify geographic and time restrictions in non-compete agreement that are broader than protection of the employer’s interests requires), with Compass Bank v. Hartley, 430 F.Supp.2d 973, 980–81 (D. Ariz. 2006) (Arizona courts can blue pencil severable, unreasonable clauses but cannot add or rewrite provisions); Gleeson v. Preferred Sourcing, LLC, 883 N.E.2d 164, 177 (Ind. Ct. App. 2008) (blue penciling by “scratching out” severable clauses permissible for non-compete agreements, but only when resulting contract is reasonable without changing other terms in contract); E. P. I. of Cleveland, Inc. v. Basler, 230 N.E.2d 552, 556–57 (Ohio Ct. App. 1967) (blue penciling permissible but only when offending clauses are severable), and with Keener v. Convergys Corp., 342 F.3d 1264, 1268 (11th Cir. 2003) (Georgia law does not allow blue penciling); L&B Transport, LLC v. Beech, 568 F.Supp.2d 689, 697–698 (M.D. La. 2008) (refusing to revise non-compete provision despite contract’s severability clause). 149 Whether, and to what extent, an amendment in writing clause will vitiate an oral amendment, or an unsigned back-of-the envelope amendment, is a function of the state law governing the contract. Compare U.S. v. Schwimmer, 968 F.2d 1570, 1575 (2d Cir. 1992) (course of conduct can waive prohibition of oral modification, particularly if “there has been performance in reliance on the oral modification”), with Lincoln Elec. Co. v. St. Paul Fire and Marine Ins. Co., 210 F.3d 672, 687 (6th Cir. 2000) (while “course of conduct” under Ohio law can be evidence of the parties’ original intent, subsequent “course of performance” is excluded by inclusion of a no amendment clause); and with Williams v. Jader Fuel Co., 944 F.2d 1388, 1395 (7th Cir. 1991) (“It is settled law in Illinois that, except for agreements concerning the sale of goods . . . ‘parties may modify contracts orally after including a contract provision that precludes


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§ .. no waiver clause Generally, the employment agreement’s “no waiver” clause provides that a waiver of a contract term must be in writing. The “no waiver” clause may also provide that waiver of one contract term does not constitute a waiver of the same term at a later time nor a waiver of any other term in the contract.150 § .. dispute resolution clause If no dispute resolution clause is included in an employment agreement (and no other stand-alone agreement exists), disputes between the parties will be resolved in the judicial system, including by trial by jury, if applicable, or by a state or federal agency with jurisdiction over the claims. Typically, dispute resolution clauses in employment agreements modify the trial by jury default. Dispute resolution clauses may require that all disputes be resolved in the judicial system without a jury or by binding arbitration. Sometimes the clause references a stand-alone agreement (usually an arbitration agreement). Binding arbitration clauses may be simply written or, in the case of some arbitration agreements, comprehensive. Comprehensive arbitration clauses often detail the arbitration procedure to be used in a dispute (e.g., number of arbitrators, right to discovery, requirement that arbitrator issue a reasoned decision). Most binding arbitration clauses permit the parties to utilize the judicial system for injunctive and other extraordinary relief in situations where there is a breach or threatened breach of a confidentiality or trade secret obligation. Arbitration may be significantly more expensive than litigation in certain situations because the parties must pay the arbitrator’s fee, and often significant filing and administrative fees. By contrast, in the judicial system, the taxpayers pay for the judge, and filing fees may be lower. Before agreeing to an arbitration clause, the executive or entrepreneur should consider who pays for the arbitration (as distinct from who pays for the attorneys’ fees) under the clause and the potential chilling effect future arbitration costs may have on his desire to resolve a dispute by arbitration. The executive or entrepreneur should consider insisting that a proposed arbitration clause require the

oral modification.’” (quoting Consol. Bearings Co. v. Ehret-Krohn Corp., 913 F.2d 1224, 1231 (7th Cir. 1990))). 150 The effect of a contractual no waiver clause is a function of state law. Compare Bott v. J.F. Shea Co., 388 F.3d 530, 534 (5th Cir. 2004) (“Texas courts consider a contract’s non-waiver clause to be ‘some evidence of non-waiver’ but not a substantive bar”), and Wyeth v. King Pharmaceuticals, Inc., 396 F.Supp.2d 280, 290 (E.D.N.Y. 2005) (“the existence of a non-waiver clause in a contract does not by itself preclude the waiver of a provision of, or right under, the contract”), with Pressman v. Franklin Nat’l Bank, 384 F.3d 182, 186 (6th Cir. 2004) (under Tennessee law, oral waiver ineffective where contract required waiver to be written and executed by both parties), and Chicago College of Osteopathic Medicine v. George A. Fuller Co., 776 F.2d 198, 202 (7th Cir. 1985) (“[T]he weight of the authority in Illinois holds that Waiver Only in Writing provisions can be waived by words and deeds of the parties, so long as the waiver is proved by clear and convincing evidence”).

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employer to pay for the costs of the arbitration. In some jurisdictions, an employer that imposes a binding arbitration clause on an employee is required to pay most or all of the arbitration costs.151 § .. governing law and venue clause The employment agreement’s “governing law and venue” clause designates the state law that applies to the construction and interpretation of the contract. The clause may also be referred to as a “choice of law and forum selection” provision. The clause almost always includes a phrase excluding the governing state law’s conflicts of laws rules. This is done in an attempt to prevent a party from later arguing that another jurisdiction’s law should apply to the contract because the conflicts of laws rules of the governing state’s law provide that the other jurisdiction’s law applies. An example of a governing law clause follows: “The law of the state of [ ______ ] shall apply to the interpretation and enforcement of this contract without reference to [ __________ ]’s conflicts of laws rules.”152 The governing law and venue clause will also frequently describe the exclusive venue for resolving disputes between the parties. The employer usually seeks venue in the jurisdiction where the executive will work or where the employer is headquartered. The executive’s choice of venue is almost always where he lives and works.153 The clause often includes the parties’ consent to personal jurisdiction in the courts for the chosen venue.

151

Compare Cole v. Burns Intern. Sec. Services, 105 F.3d 1465, 1485 (D.C. Cir. 1997) (requiring employer to bear costs of arbitration of employment discrimination claim where mandatory arbitration required by employment contract), Gibson v. Nye Frontier Ford, Inc., 205 P.3d 1091, 1101 (Alaska 2009) (employer requiring employee to arbitrate wage and hour claim must pay arbitration costs), and Armendariz v. Foundation Health Psychcare Services, Inc., 6 P.3d 669, 765 (Cal. 2000) (“[W]e conclude that when an employer imposes mandatory arbitration as a condition of employment, the arbitration agreement or arbitration process cannot generally require the employee to bear any type of expense that the employee would not be required to bear if he or she were free to bring the action in court”), with Morrison v. Circuit City Stores, Inc., 317 F.3d 646, 658-59 (6th Cir. 2003) (“Although the Tenth, Eleventh, and D.C. Circuits have suggested that such cost-splitting provisions per se deny litigants an effective forum for the vindication of their statutory rights, most courts, including this one, that have addressed this question have held that this issue must be decided on a case-by-case basis”), Blair v. Scott Specialty Gases, 283 F.3d 595 (3d Cir. 2002) (case remanded to district court for determination of whether arbitration costs would be prohibitively expensive for employee), and Taylor Bldg. Corp. of Am. v. Benfield, 884 N.E.2d 12, 25-26 (Ohio 2008) (employee required to show costs are prohibitive to avoid mandatory arbitration provision). 152 Some agreements use the following (or similar) provision: “This Agreement shall be deemed to be negotiated and entered into entirely in the State of [ ______ ].” 153 Courts sometimes disregard governing law and venue clauses, particularly when the choice of law or venue will lead to a result contrary to the policy of the state in which the courts sit. See, e.g., Application Group, Inc. v. Hunter Group, Inc., 72 Cal.Rptr.2d 73, 82 (Cal. App. Ct. 1998) (“where application of a choice-of-law provision would result in the contravention of California’s public policy, the provision will be ignored to the extent necessary to preserve public policy”); Bell v. Rimkus Consulting Group, Inc. of Louisiana, 983 So.2d 927, 933 (La. Ct. App. 2008) (nullifying forum selection clause as applied to noncompete agreement); DeSantis v. Wackenhut Corp., 793 S.W.2d 670, 681 (Tex. 1990) (determining


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§ .. no mitigation clause A “no mitigation clause” prevents an employer from asserting that even though it has breached the employment agreement by failing to pay the required benefits, the exemployee has a duty to mitigate, that is, reduce his damages (which, in turn, means the employer has less damages and benefits to pay). A broadly written “no mitigation clause” in an employment agreement might provide as follows: “Executive shall have no duty to mitigate any breach by the Company of this Agreement.” A no mitigation clause limited to compensation and equity might provide: “Executive shall have no duty to mitigate any breach of the Company’s obligation to provide the wages, bonuses, commissions, severance, equity, and accelerated vesting described in this Agreement.” The no mitigation clause discourages an employer from playing hardball with benefits in the event of a rancorous termination of the executive’s employment. Even where the employer’s “failure to mitigate” argument approaches frivolity, it may have economic value to the employer playing hardball. Executives rarely know what a “no mitigation clause” is or how the super legalese provision protects them. They also have difficulty understanding this clause. The following explanation should help: A no mitigation clause is total legalese, but it will protect you if the company decides some day to play hardball, breach its contract with you, and not pay you what it agreed to pay you. Even though it is not written into the contract, as a matter of contract law, everyone who signs a contract has a duty to mitigate, that is, reduce the damages he suffers if the other side breaches the contract. The best way to explain this is to start outside the employment context. Let’s say you own an almond company in San Francisco and a company in New York contracts with you to buy $1 million of almonds. After signing the contract, you ship the almonds to New York, and on the receiving dock in New York the person who ordered the almonds says, “You know what, I don’t want the almonds anymore. Get them out of here.” You cannot simply sue the New York company for $1 million. You have a legal duty as a matter of contract law to attempt to reduce your damages. So, if you find a company in Philadelphia to buy the almonds for $500,000, you have a duty to sell the almonds to the Philly company for the $500,000. Transaction costs aside, your lawsuit against the New York company that contracted for the almonds is not for $1 million, but rather for the $500,000 you lost after you mitigated your damages.

enforceability of non-compete agreement under Texas law, despite forum selection clause designating Florida).

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What a “no mitigation clause” would do in the almond sale contract is eliminate your obligation to go find the Philadelphia company. The “no mitigation clause” says to the New York almond buyer, “a deal is a deal, and you owe me the $1 million whether you accept delivery of the almonds or not.” In the employment context, when the employee is wrongfully fired, he cannot just sit around and sue the employer for damages. Instead, the employee has an obligation, as a matter of employment contract law, to go out and look for a similar job, in a similar location, to mitigate the damages he suffered from the wrongful termination. If the fired employee finds a better job at higher pay with more equity, he probably cannot sue his ex-employer because, in the eyes of the law, the termination was a good thing for the employee. The problem in your executive employment context is that you don’t want a company firing you and refusing to pay you your severance and refusing to accelerate your stock option vesting, and thereafter, claim that it owes you nothing because you can go out and get a better job at higher pay with more valuable options. I’m not sure whether an employer can legally and successfully argue that it is possible to mitigate the acceleration of an option, or a lump sum severance payment, but you do not want to allow the company to raise the argument. Imagine if your stock subject to acceleration is worth $20 million and the company refuses to accelerate your shares on the grounds that you have a duty to mitigate. You might decide to settle for $15 million immediately, rather than risk an adverse outcome, and the company would have gained $5 million for no good reason. A no mitigation clause says to both you and your future employer, “a deal is a deal,” and the employer must pay you what it has agreed to pay you.

§ .. headings clause The headings clause usually provides that headings in the employment agreement are for convenience only. Should a dispute arise, the headings are not to be used in interpreting the agreement.

§ .. notice clause The employment agreement’s “notice” clause sets out the ways that notice may be given, and usually the length of time each method of notice is deemed to take, under the contract.

§ .. entire agreement — integration clause The “entire agreement” or “integration” clause usually provides that the employment agreement is the parties’ final agreement, and all prior or contemporaneous oral and


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written agreements and understandings are superseded in their entirety by the employment agreement. This clause means that whatever the executive believes he is entitled to must be written into the employment agreement. Otherwise, the executive will not have a contract claim for whatever it is he thinks he is due. The employment agreement’s integration clause should reference all contracts that are part of the executive’s employment relationship to ensure that the integration clause does not nullify an earlier signed contract.154 § .. counterparts and signing clause The parties often desire to execute the employment agreement when they are physically in different locations. To accomplish this goal, they may include a fairly common clause allowing the parties to enter into the employment agreement in counterparts and by facsimile signature or by signing, scanning, and e-mailing. Following is an example of a counterparts and signing clause: “This Agreement may be entered into by facsimile signature or by signing, scanning, and e-mailing, and in counterparts, each of which shall be deemed an original, and all of which taken together shall be one original instrument.”

§ 7.5 Stock Option and Other Equity Agreements

Key provisions of stock option and other equity agreements are discussed at § 4.4 and at § 7.4.6.

§ 7.6 Employee Confidential Information and Invention Assignment Agreement

Employment is usually made contingent on the executive signing a confidential information and invention assignment agreement which, as explained in § 4.5, goes by many names. The employment agreement will usually explicitly state this requirement. Most executives spend little time reviewing the CIIAAs they will be required to sign. Almost every CIIAA does the following: • Broadly defines the employer’s confidential and proprietary information;

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Some states provide by statute that contracts negotiated contemporaneously should be interpreted together. See, e.g., Cal. Civ. Code § 1642. But even where these states’ laws apply, the safest approach is to cross reference in the employment agreement all contracts that are part of the employment relationship.

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• Prohibits the employee from disseminating the employer’s confidential and proprietary information and trade secrets without written permission both during and after employment; • Provides that all patents, copyrights, and other intellectual property created during employment belong exclusively to the employer and are assigned to the employer; • Provides a mechanism for assigning patents to the employer in the event the employee is incapacitated, cannot be found, or is unwilling to sign patent assignment papers; • Prohibits the employee from using prior employers’ confidential information during employment; • Requests a list of all preexisting inventions and employee-owned intellectual property. CIIAAs for California employees must also contain a California Labor Code § 2870 disclosure.155 The California statute provides that an employee who creates a product unrelated to his employer’s business on his own time, without use of employer facilities or resources, owns the intellectual property. Beware: The CIIAA may contain clauses harmful to the executive, either because they are overly broad, or because the clause is an atypical provision added to the CIIAA. CIIAAs are sometimes used as a catch-all document. Following are some clauses to watch for: • Overly broad definition of “confidential information.” CIIAAs frequently contain overly broad definitions of “confidential information,” so broad that one might wonder whether the overly broad definition will “hurt” the employer if the scope of the clause were ever litigated.156 As a practical matter, most employers will not negotiate—even for the CEO—the definition of “confidential information” in their CIIAAs. • Requirements that do not fit the executive’s position or responsibilities. Most employers have a standard CIIAA that they ask all employees to sign before beginning employment. As a matter of policy, these employers may send the executive a form CIIAA to sign. The employer’s standard CIIAA will probably contain restrictions that are not appropriate for the executive. One that frequently arises is the CIIAA clause prohibiting the employee from disclosing the employer’s confidential or proprietary information or trade secrets to anyone or anything without the express written consent of the employer’s board of directors (or perhaps its CEO).

155 156

See Chapter 4, footnote 15. Employers include overly broad definitions, in part, to ensure they do not leave anything out of their definitions, in part for a “chilling effect” on prospectively wayward employees, and in part in case they must someday litigate against the employee.


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This restriction makes no sense for CEOs, COOs, CFOs, and perhaps other senior executives (e.g., vice presidents of worldwide sales), because it is their responsibility to determine when the best interests of their employer require disclosure of the employer’s confidential and proprietary information and trade secrets. However, the executive certainly does not want to violate the CIIAA while doing his job, especially if the definition of “Cause” in his employment agreement can be triggered by a breach of the CIIAA. To protect your executive client, you should do one or more of the following: (i) remove the offending language in its entirety; (ii) modify the offending language by including a provision similar to the following: “Executive may disclose the Company’s confidential or proprietary information or trade secrets in the course and scope of his employment when Executive does so without personal gain, and when, in Executive’s good faith judgment, disclosure of the information is in the Company’s best interest”157; or (iii) modify the definition of “Cause” in all applicable documents to specifically exclude the conduct described in (ii) above. • At-will employment clause. Some CIIAAs include an at-will clause, providing that the signatories’ employment is at will. These same CIIAAs will invariably include an integration and superseding clause. As a technical matter, if the CIIAA is signed after the employment agreement, and the CIIAA contains an integration clause, the CIIAA’s “at-will” clause may vitiate the protections on separation included in the employment agreement. To avoid this potential problem, the CIIAA’s at-will clause should be modified to provide that while employment is at will, the employment relationship is subject to the terms (severance and acceleration provisions) set forth in the employment agreement. • Employer’s right to disclose the CIIAA to the Executive’s future employers. CIIAAs sometimes contain a clause giving the employer the right to send a copy of the CIIAA to the executive’s future employers. Some executives believe that this clause unnecessarily allows the employer to aggressively interfere with a potential later employment relationship. They fear that a letter enclosing a copy of the CIIAA from their current employer to a future employer may have a “chilling” effect on a future employment relationship. This concern may be addressed by negotiating for the elimination of the clause from the CIIAA. • Arbitration clause. CIIAAs sometimes include an arbitration clause. Arbitrating executive employment disputes is not necessarily a bad idea. However, the executive should be advised if an arbitration clause appears in his employment-related agreements, and that the clause means, as almost all invariably do, that he is giving up his right to a trial by jury and to utilize the judicial system to resolve employment-related disputes.

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This (or substantially similar) language may be included in the employment agreement or other executive agreement, providing that the agreement containing the language is drafted in a way to supersede and/or modify the offending CIIAA clause.

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Appendix Example of a Letter to Client Regarding an Employment Offer

Letters to executive and entrepreneur clients regarding their employment documents must be individually written. Every executive’s or entrepreneur’s prospective employment situation is unique. While many of the same comments, suggestions, and warnings may appear in your letters, you must revise the content of each letter for the particular executive or entrepreneur and his situation. Following is a sample rough draft letter to an executive considering a senior position at a private investor–backed company, where the executive has received an initial employment offer lacking many of the protections described in this book. *** Date158 Mr. Executive Home Street Address Good City, California 12345 Re: Your Employment Offer Dear Mr. Executive: As you requested, I reviewed the ABC Corporation (“ABC” or “Company”) Offer Letter (“Offer Letter”) and the ABC Confidential Information and Invention Assignment Agreement (“CIIAA”) you sent me. You have not sent me any other employment-related documents to review. Employment-related documents which you have not sent me include [ ______________ ]. Obviously, I cannot comment on documents I have not seen. I urge you to send all other employment-related documents to me to review before you join the Company. General Comments and Suggestions As a general matter, your Offer Letter is weak and does not protect you in many important ways, including without limitation:

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The author retains the copyright to this example letter.


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You have no protection (e.g., no severance, no COBRA premium payments, no accelerated vesting) if the Company terminates you without cause. You have no protection if the Company demotes or otherwise mistreats you during your employment. You have no protection in the event the Company undergoes a corporate change in control. Your equity interest in the Company is not protected. You will lose all of your unvested shares subject to your employee stock option when your employment terminates. Because your employee stock option has a one-year cliff vesting term, if the Company terminates your employment on the 11th month and 15th day of your employment, you will receive no equity in the Company. Without equity protection, if your employment is terminated without cause or you quit because you are mistreated during the first year of your employment, you will not receive any equity. The prorated, monthly vesting of your equity begins only after the first year of employment. Companies have wide discretion to hire, fire, and reassign their employees, and change their employees’ rate of pay. An executive protects himself against employment termination, reassignment, and a reduction in wages by negotiating for “termination without Cause” and “Good Reason to resign” (sometimes called “constructive termination” or “involuntary termination”) clauses. A termination without “Cause” clause will provide you severance, COBRA premium payments, accelerated equity vesting and [ __ ] in the event the Company terminates your employment for reasons that have nothing to do with you acting improperly. A “Good Reason” clause will provide you severance, COBRA premium payments, accelerated equity vesting and [ __ ] in the event the Company materially reduces your job title, authority, responsibilities, salary, benefits, or reporting relationship, or requires you to move, fails to require a successor-in-interest to assume the obligations in your Offer Letter, or otherwise mistreats you. I urge you to negotiate for severance, COBRA premium payments, accelerated equity vesting and [ __ ] in all cases if the Company terminates your employment without “Cause” or you have “Good Reason” to resign. Terms should include, at a minimum, a salary payment for a negotiated number of months, plus COBRA coverage (or insurance premium reimbursement) for a negotiated number of months, accelerated vesting of your equity for a negotiated period of time, plus [ __ ]. Given that you will be joining the Company as a senior executive reporting to [ ___________ ] with significant responsibility for [ _____________ ], you should negotiate for, at a minimum, [ _______ ] months’ severance, [ ______ ] months paid COBRA benefits, and [ _________ ] accelerated equity vesting in the event you are

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terminated without Cause or have Good Reason to resign (The [ _________ ] minimum accelerated vesting should forward vest you to the point that you would vest had you worked [ _______ ] beyond your employment termination date. This type of accelerated vesting protects you against reduced equity acceleration if you are terminated during the initial cliff vesting period). Should you want me to do so, I will be happy to provide you with protective language for termination without Cause and Good Reason to resign clauses. Among other things, you are better off with a narrow definition of Cause and a broad definition of Good Reason. My specific comments on your Offer Letter follow. The numbers to the left below correspond to the section numbers in your Offer Letter.

Offer Letter §1

Are you satisfied with the title, [ ___________ ]?

What will be your responsibilities as [ __________ ]? I recommend that you detail your responsibilities in your Offer Letter to avoid potential confusion down the road. Detailing your responsibilities now may also help protect you in the event you negotiate for a Good Reason to resign clause, and at some time in the future, you decide to trigger the clause. If you would like the right to teach, volunteer in local, religious, or community based activities, give presentations, serve on other company advisory boards or boards of directors, or undertake other volunteer or business-related activities, add a clause to this section confirming your right to do so. If it is important to you to report only to the [ ______ ], change “Your manager will be [ ___________ ]” to, “Your only manager will be [ __________ ].” In addition, you must negotiate for a Good Reason to resign clause and add a Good Reason trigger for a change in your reporting relationship. Do you want to serve on the Company’s Board of Directors (“Board”)? If so, the Offer Letter should be modified accordingly. §2

Is the base salary of [ __________ ]/year acceptable?

Consider adding: “Your base salary will be reviewed by the [Company’s Board of Directors] [CEO] [your manager] at least once a year and will be increased if the [ _______ ], in [his] [its] sole discretion, determines an increase is warranted.” §3

Is the bonus potential of [ ____ ]% sufficient?


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What is the period in which the bonus plan is in place? Will your bonus for this year be pro-rated? You should learn everything possible about the bonus before joining the Company. Is the Company able to define your bonus objectives now, before you start work? Consider setting out the metrics/milestones in the Offer Letter for your first year bonus so that it is clear when you earn your bonus. In the alternative, consider negotiating for a guaranteed bonus for the remainder of this year, or for the first [quarter] [six months] [year] of your employment. Assuming the annual bonus period runs from January 1st to December 31st of every year, consider adding, “The [Company] [Board] will give you your bonus performance objectives on or before [ _________ ] of the applicable year. If the [Company] [Board] fails to do so, then your bonus will be a guaranteed bonus for the applicable year.” § 4 I urge you to review all of the Company’s employee benefit plans before joining the Company. § 5 If there are certain business expenses you want the Company to pay that it might not otherwise pay, the specific expenses should be added to this reimbursement of business expense clause. For example, if you want the Company to pay for [business class flights] [ ___________ ] when you travel, add a clause requiring it to do so. § 6 You advise that [ ______ ] shares of Company common stock is [ ___ ]% of the fully diluted capital of the Company on an as converted to common stock basis. You advise you would like to negotiate for additional shares, up to [ ___ ]% of the fully diluted capital of the Company. You should add the following to this section: “[the number of shares you eventually negotiate] shares of Company common stock is [the percentage you negotiate]% of the fully diluted capital of the Company on an as converted to common stock basis (including, without limitation, all common stock, preferred stock, options, warrants, and convertible debt and all stock reserved for issuance as part of the Company’s employee stock option pool).” What is your expectation regarding dilution of your equity interest in the Company? Consider adding an anti-dilution clause to protect you against dilution in future rounds of financing. You should understand the rights and preferences associated with all of the Company’s preferred stock and other equity before joining the Company. What are the liquidation preferences for the Company? Liquidation preferences may be very important if the Company is sold. If the liquidation preferences are sufficiently high and the Company’s sales price is not high enough, common stockholders may receive little or nothing from the sale of the Company. For example, if the Company’s liquidation preferences are $100 million and the Company is sold for $100 million, all of the money from the

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sales price may go to the investors with none of the money being distributed to you as a common stockholder. Consequently, the value to you of an option for [ ___ ]% of the Company’s equity may depend, in significant part, on the liquidation (and other preferences) of the preferred stock of the Company. It is absolutely critical that you are fully informed about the Company’s capital structure, including liquidation preferences (sometimes called the “overhang”), before you join the Company. If liquidation preferences are significant, I urge you to negotiate for a management carve-out agreement (which would pay you some portion of the Company’s sales price in the event your equity is worth little when the Company is sold) so that you will realize a benefit from the Company’s sale, should the Company be sold. If you have any questions about liquidation preferences or other capital structure issues, please ask me. It is important for you from a tax perspective to have your option granted at an exercise price equal to or above the fair market value of the Company’s common stock on the date of grant. Consider adding a clause requiring the Company to pay all taxes, penalties, and interest you incur if any government taxing authority determines that the Company granted your option at an exercise price below fair market value. Will your stock option be an incentive stock option or a non-qualified stock option? Does this matter to you? Add the following to this section: “Your vesting commencement date will be the first day of your employment.” Your Offer Letter states that you will be able to early exercise your stock option should you want to do so. Early exercising your stock option means you may exercise your stock option and pay for your stock at any time, whether or not your stock option is vested. (The Company will have the right to repurchase any unvested stock at the exercise price if your employment terminates before the stock vests.) Exercising your unvested stock option at the start of your employment has its advantages and disadvantages (risks). One significant advantage: You may exercise your stock option, and file an 83(b) election with the United States Internal Revenue Service, within thirty (30) days of the grant date of your stock option. Thereafter, if you hold the stock for at least one year and if the stock goes up in value, at the time you sell the stock, you incur only capital gains taxes (not ordinary income taxes). One major disadvantage (risk): You may lose all the money you pay to exercise the stock option if the Company fails. Even if the Company succeeds, the stock will probably be illiquid (and your money tied up) for some time. If you will not be early exercising your stock option, then I strongly recommend you negotiate for an extended post-termination exercise period (e.g., one, two or three years) if your employment is terminated without Cause by the Company or for Good Reason by you.


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This section states that your stock option will be subject to the terms and conditions of the Company’s Equity Plan, notice of stock option grant and stock option agreement. [You have not sent me a copy of these documents. Obviously, I cannot comment on documents I have not seen. I urge you to send me these documents so I can review them for you before you join the Company.] As explained above, your equity is completely unprotected. I urge you to negotiate for accelerating vesting in the event the Company terminates your employment without Cause or you resign your employment for Good Reason. Consider adding the following to this section of the Offer Letter: “Management believes, in good faith, that the Board will approve your stock option at the Board’s first meeting following your start date.” § 7 Because you will be an at-will employee, the Company may reassign you or terminate your employment at any time, with or without Cause, with or without explanation, for any reason or no reason at all (except for an illegal reason), and with or without notice; and you are unprotected against this possibility. You will not receive severance pay, nor COBRA or other medical benefits, nor any equity protection (e.g., acceleration) if your employment is terminated without Cause. Similarly, you have no recourse if the Company demotes you, cuts your salary, requires you to move, or mistreats you. You will not receive any severance, paid COBRA benefits, or any accelerated vesting if this happens. § 8 If you are a party to an agreement that you believe prohibits or limits you from working for the Company, please let me know immediately. § 9 You should carefully review all of the Company’s “rules and policies” before joining the Company. In addition, ask the Company whether it has a Company Handbook, and if so, you should send it to me for review (and carefully review it yourself) before joining the Company. § 10 This section states that your employment is contingent on you signing your CIIAA. I comment on your CIIAA separately. § 11 This section states that the Offer Letter and CIIAA supersede all previous written and oral agreements between you and the Company. Among other things, this clause and the documents listed will nullify all oral and written understandings between you and the Company. If you were promised something in your employment negotiations or believe you are entitled to something as part of your negotiations, whatever you were promised, or believe you are entitled to, must be written into the Offer Letter. Otherwise you may not receive what you were promised and/or what you believe you are entitled to. § 12 Your employment offer will terminate if the letter is not signed by the date set forth in this section. If you need additional time, consult with the Company and modify the Offer Letter accordingly.

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Additional Clauses to Consider Adding to Your Offer Letter Attorneys’ Fees for Review of Employment-Related Documents: Consider negotiating for the Company to pay the attorneys’ fees and costs you incur in connection with the review of your employment-related documents. Some employers will pay the attorneys’ fees and costs incurred by executives with whom they are negotiating. Change in Control: Consider negotiating for accelerated vesting of some portion or all of your unvested stock (and/or other benefits) in the event the Company undergoes a corporate change in control. Accelerated vesting (and/or other benefits) caused by a change in control need not be linked to the termination of your employment. Indemnification: You should request a separate indemnification agreement which sets out the Company’s duty to indemnify and defend you, and advance fees and costs, in the event you are sued and/or are the subject of an investigation related to the Company. I suspect the Company has already adopted a form indemnification agreement for its officers and/or directors. If not, it can surely obtain a form indemnification agreement from its attorneys (or I can provide you with one). It is possible that the Company has included the Company’s obligation to indemnify its directors and/or officers in its bylaws or other corporate governance documents. If this is the case, please send me the documents to review. If the Company’s corporate governance documents contain indemnification language, then a clause should be added to your Offer Letter confirming the Company’s obligation to indemnify you. In the event the Company has no approved indemnification agreement for its executives and does not include an indemnification obligation in its corporate governance documents, then I urge you to add the following to your Offer Letter: The Company shall indemnify you to the fullest extent permitted by [state in which corporate headquarters are located] and/or [state in which employment will take place] law for all claims, allegations, investigations, or settlements of any kind brought or alleged to be brought against you, at any time, for any act or omission in any way related to your service to the Company, and in connection with this obligation, the Company shall immediately advance all costs and expenses, including attorneys’ fees, to you at any time you demand an advancement of costs and/or expenses. The Company’s indemnification obligation shall be construed as broadly as possible. Consider negotiating for an assurance that you will be a covered insured (or your position will be specifically covered) on the Company’s directors’ and officers’ employment liability and errors and omissions insurance policies in the event the Company purchases one or more of these policies.


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No Duty to Mitigate: If you negotiate for protection in the event your employment is terminated without Cause or you resign for Good Reason, then I urge you to include a “no duty to mitigate clause” in your Offer Letter as follows: “You have no duty to mitigate any breach by the Company of any of the terms of this Offer Letter.” This clause protects you in the event the Company breaches its obligations to pay you severance and/or accelerate your vesting (if you negotiate for these terms), and then the Company argues you should seek and obtain alternate work to reduce the damages it has caused you. Parachute Payments: Parachute payments may occur if you receive severance and/or accelerated vesting in connection with a change in control (as currently drafted, the Offer Letter does not provide you with severance or accelerated vesting). You may be required to pay an additional 20 percent excise tax on parachute payment–related amounts. In the event any of the payments to be made to you under the Offer Letter constitute parachute payments and trigger additional excise taxes, consider requiring the Company to pay you, in addition to all other payments, an amount equal to the grossed-up additional excise taxes you are required to pay on the parachute payments. Registration Rights: Although you will probably not receive them, you might consider negotiating for registration rights to require the Company to register your stock in certain circumstances. If you are interested in registration rights, I will be happy to discuss them with you. Signing Bonus: Consider negotiating for a signing bonus. Vacation: The Offer Letter does not discuss holidays, vacation, or paid time off (“PTO”). You should review the Company’s PTO policy before joining the Company. Consider confirming the number of vacation days, sick days, and/or PTO days to which you will be entitled. Also, consider whether the Company is closed for a week or more during the Christmas to New Year’s period, and if so, whether this forced time off counts against your PTO. § 409A: If you negotiate for severance, in addition to including the severance in the Offer Letter, you must add certain language to prevent you from triggering Internal Revenue Code § 409A’s onerous tax, penalty, and interest provisions. I will be happy to provide you with the appropriate language if needed. *** [As you know, I am not a tax attorney] [As you know, I am not intimately familiar with all of your personal tax considerations]. [Please consult your tax advisor for all tax-related issues arising out of or related to your Offer Letter and your related equity agreements]. If you have any questions or concerns, or would like to discuss anything I have written in this letter, please give me a call and/or send me an e-mail. Sincerely,

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Sample Employment Agreement

The employment agreement below contains many, although not all, of the clauses and protections discussed in this book and should be reviewed in connection with this book’s text. There is no such thing as a “standard” employment agreement for executives and entrepreneurs because each employment agreement must be individually negotiated and drafted. Consider the sample below a very rough form, which must be modified for the particular executive’s or entrepreneur’s situation and the applicable state and federal law. *** EMPLOYMENT AGREEMENT159 This employment agreement (“Agreement”) is between [ ___________ ], a [ _______ ] corporation (“Company”) with its principal place of business at [ _____________________ ], and [ _______________ ] (“Executive”) who lives at [ ____________________ ]. This Agreement is effective on [ _______________ ] (“Effective Date”), which shall be the Executive’s first day of employment. WHEREAS, the Executive and the Company enter into this Agreement to describe the terms and conditions under which the Company shall employ the Executive. NOW, THEREFORE, in consideration of the mutual covenants and promises contained in this Agreement, the parties agree as follows: 1. Employment. The Executive shall serve only as [ ______________ ] of the Company, reporting only and directly to [ ________________ ]. The Executive’s principal place of employment shall be the Company’s offices at [ __________________ ]. The Executive shall be responsible for: [ ____________________________ ]. [2. Board Seat. The Executive shall also be appointed a member of the Company’s Board of Directors (“Board”). The Company shall ensure that the Executive serves on the Board at all times while Executive is employed by the Company.] 3. At-Will Employment. The Executive’s employment with the Company shall be “at will,” and either the Executive or the Company may terminate the Executive’s employment at any time, for any reason, with or without Cause, and with or without notice, providing that, in all cases, the termination is subject to all of the severance and equity acceleration terms in this Agreement.

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The author retains the copyright to this sample employment agreement.


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4. Best Efforts. The Executive shall devote his best efforts and his full business time and services to the performance of his duties under this Agreement and shall not engage in any other employment, occupation, consulting, or other business activity that conflicts with the business of the Company. Notwithstanding any other term in this Agreement, the Executive may engage in charitable, teaching, lecturing, religious, community service, volunteer, industry association, and [ ____________________ ] activities and manage his personal investments, as long as the activities do not interfere with the performance of his duties under this Agreement. The Executive may invest in and hold up to [ ___ ] percent ([ __ ]%) of any [publicly traded] [ ________ ] company. The Executive may also serve on other companies’ boards of directors or advisory boards, as long as the other companies do not compete with the Company and the Executive’s service to the companies does not interfere with the performance of his duties under this Agreement. 5. Base Salary. The Executive shall receive a base salary of $[ _______ ] per year (“Base Salary”), payable in equal regular installments, less legally required withholding, in accordance with the Company’s customary payroll practices. The Board shall review the Executive’s Base Salary at least once a year and shall increase the Executive’s Base Salary if, in the sole discretion of the Board, an increase is warranted. 6. Signing Bonus. The Company shall pay the Executive a signing bonus of $[ ____________ ] (“Signing Bonus”). The Company shall pay the Signing Bonus to the Executive on or before the Company’s first regular payroll after the Effective Date. 7. Annual Performance Bonus. For each calendar year while the Executive is employed by the Company, the Executive shall be eligible for a performance-based bonus (“Bonus”). The Executive’s target annual Bonus shall be [ _________ ] percent ([ __ ]%) of the Executive’s Base Salary (“Target Bonus”). The Executive’s Bonus for the remainder of the first calendar year of the Executive’s employment [shall be prorated for the number of days the Executive works in the year] [shall be _____________ ]. After good faith discussions with the Executive, the Board shall establish performance criteria for the Executive’s Bonus for the remainder of the Executive’s first calendar year as soon as reasonably practicable following the Effective Date, but in no event later than [ _______________ ]. For all future years, the Board, after good faith discussions with the Executive, shall establish performance criteria for the Executive’s Bonus by [January 31st] [ __________ ] of the applicable year. If the performance criteria for the Bonus are not established by [ _________ ], or in later years by [January 31st] [ __________ ] of the applicable year, then [the failure to establish the applicable Bonus Plan performance criteria shall be deemed a material diminution of the Executive’s bonus potential for purposes of this Agreement] [the Bonus shall be guaranteed Bonus for the rest of the applicable year] [ _________________________ ]. All Bonuses shall be fully earned on December 31st of the applicable year and shall be paid to the Executive within thirty-one days of December 31st, regardless of whether the Executive is employed after December 31st.

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8. Equity Grants. A. Stock Option. The Company shall recommend to the Board that the Board grant the Executive an option (“Option”) to purchase that number of shares of the Company’s common stock equal to [ ________ ] percent ([ ___ ]%) of the fully diluted capital of the Company on an as converted to common stock basis (including, without limitation, all Company common stock, preferred stock, stock reserved for issuance under any Company equity plan, restricted stock, warrants, options, and convertible debt). The Option will be issued pursuant to the terms of the Company’s 2011 Equity Plan (“Plan”) and a stock option agreement reflecting the grant of the Option (“SOA”). The Plan and a form SOA are attached as Exhibit 1 to this Agreement. Unless the Executive requests otherwise before the date of grant of the Option, the Option shall be an incentive stock option to the fullest extent permitted by law. The Option shall be immediately exercisable, providing that all unvested shares shall be subject to repurchase by the Company at the exercise price. The Option may be exercised until the [ ___________ ] anniversary of the termination of the Executive’s employment. The maximum term of the Option shall be [ten years] [ _____ ]. The Option shall vest as follows: [ ______________ ].The per share exercise price of the Option shall be equal to the fair market value of one share of the Company’s common stock on the date of grant, as determined in good faith by the Board. The Company shall pay the Executive the fully grossed-up amount of all taxes, penalties, and interest the Executive incurs in the event a government agency determines that the exercise price of the Option is below the fair market value for a share of the Company’s common stock on the date of grant, and the gross-up payment shall be made to the Executive within ten days after the Executive pays the applicable taxes, penalties, and interest. The SOA shall reflect all stock option-related terms of this Agreement. [B. Additional Equity Grant. The Company shall recommend to the Board that the Board grant the Executive [ _____________ ] (“Equity Grant”).] C. Automatic Extension of Time to Exercise. The time period for the Executive to exercise his Option after the termination of the Executive’s employment shall be automatically extended (i) in the event that the Company is unwilling or unable to issue or deliver stock to the Executive when the Executive exercises the Option, or attempts to exercise the Option; (ii) if the Company’s stock is publicly traded, in the event the Company is unwilling or unable to issue the Executive freely tradable registered stock when the Executive exercises, or attempts to exercise the Option; or (iii) if the Company’s stock is publicly traded, in the event the Executive is unable to sell the Company’s common stock on the public market because the Executive is locked out or blacked out from selling the Company’s common stock and/or in possession of material non-public information about the Company. The automatic extension shall be until the date [ ___ ] [days] [years] after the first date on which the Company is willing and able to issue and/or deliver the Executive common stock, or registered common stock, as applicable, providing that if the Company is public, the automatic extension shall be until the date [ ____ ] [days] [years] after the first date that both of the following conditions are satisfied: (a) the Company is willing and able to issue


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and/or deliver the Executive freely tradable registered common stock and (ii) the Executive is able to sell the Company’s common stock on the public market. This clause shall only extend (and never limit) the time the Executive has after the termination of his employment to exercise his Option, providing that the extension cannot exceed the maximum term of the Option. D. Management Representation. Management believes, in good faith, that the Board will approve all equity grants described in this Agreement at the Board’s first regularly scheduled meeting after the Effective Date, which will take place on [ ___________ ]. 9. Employee Benefits. The Executive shall be entitled to participate in all benefit plans, policies, or arrangements sponsored or maintained by the Company from time to time for its executive employees, including paid time off, health care benefits, 401(k) plan, [ ___________________ ]. 10. Reimbursement of Expenses. The Company shall reimburse the Executive for all reasonable expenses incurred by the Executive in the course and scope of his employment, including, without limitation [ _____________________________ ]. All expenses shall be reimbursed in accordance with the Company’s expense reimbursement policy. In addition, the Company shall reimburse the Executive for [ _____________________________ ]. [11. Relocation Expenses. The Company shall pay or reimburse the Executive up to an aggregate amount of $[ ________________ ] for the reasonable, documented, out-ofpocket expenses incurred by the Executive in connection with relocation, on or before [ ___________ ], from his current residence to [ ______________ ]. Reasonable expenses shall include, without limitation: [ _______________________ ].] [12. Other Benefits. The Company shall [ ______________________________ ]. 13. Attorneys’ Fees. Within thirty days of the Effective Date, the Company shall pay the [reasonable] attorneys’ fees [up to $______ ] incurred by the Executive in connection with the review and negotiation of this Agreement and all related agreements. [14. Management Carve-Out Agreement. Contemporaneously with entering into this Agreement, the Company and the Executive shall enter into the Management CarveOut Agreement attached as Exhibit 2 to this Agreement.] [15. Change in Control Agreement. Contemporaneously with entering into this Agreement, the Company and the Executive shall enter into the Change in Control Agreement attached as Exhibit 3 to this Agreement.] 16. Indemnification Agreement and Insurance Policies. Contemporaneously with entering into this Agreement, the Executive and the Company shall enter into the Indemnification Agreement attached as Exhibit 4 to this Agreement. In the event the

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Company purchases one or more directors and officers, employment liability, and/or errors and omissions insurance policies (or substantially similar insurance policies), then [the Executive shall be a named insured on] [the Executive’s position shall be specifically covered by] all of the Company’s policies so that the Executive is fully covered by all policies in force at all times during and after the Executive’s employment. 17. Confidential Information and Invention Assignment Agreement. Contemporaneously with entering into this Agreement, the Executive shall sign the Confidential Information and Invention Assignment Agreement, which is attached as Exhibit 5 to the Agreement. 18. No Conflicting Agreements. The Executive represents that there are no agreements to which he is a party that would prevent the Executive from entering into this Agreement. 19. Termination of the Executive’s Employment. A. Termination of Employment for Cause or Without Good Reason. If the Executive’s employment is terminated by the Company for Cause or by the Executive without Good Reason, then the Company shall pay to the Executive all accrued but unpaid Base Salary, all accrued but unused vacation, and all accrued but unpaid bonuses, and thereafter, the Company shall have no further obligation to the Executive. B. Termination of Employment Without Cause or for Good Reason. If the Executive’s employment is terminated by the Company without Cause or by the Executive for Good Reason, providing that the termination of the Executive’s employment constitutes a “separation from service” within the meaning of Treasury Regulation § 1.409A-1(h) (“Separation”), and the Executive executes and does not revoke the general release of claims attached as Exhibit 6 to this Agreement within fifty (50) days after the Executive’s Separation (“Deadline”), then, on the eighth (8th) day after the Deadline, the Company shall (i) pay to the Executive [ _____________ ], in one lump sum; (ii) accelerate the vesting of [ ___________ ]; (iii) extend the time for the Executive to exercise the vested portion of the Executive’s Option through and including the [ ______ ] year anniversary of the Executive’s Separation; and (iv) [ _____________ ]. In addition, the Company shall reimburse the Executive for [ ____ ] months of COBRA premium payments paid by the Executive (and not reimbursed by any third party), providing the Executive timely elects COBRA coverage. [On or before the thirtieth (30th) day after the Deadline, the Company shall reimburse Executive for all as yet unreimbursed business expenses in accordance with Company policy, providing that Executive has submitted all expenses for reimbursement on or before the fifteenth (15th) day after the Deadline.] C. Termination of Employment Because of Death or Disability. If the Executive’s employment is terminated because of death or disability, then [ ________________ ].


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D. Definitions. i. For purposes of this Agreement, “Cause” shall mean only the Executive’s: (i) willful and repeated refusal to follow a lawful and reasonable directive of the Company’s Board; (ii) willful, material, and repeated gross neglect of his obligations to the Company, which causes a material economic loss to the Company; or (iii) conviction of a felony crime involving moral turpitude. The Executive shall not be terminated for Cause under (i) and (ii) above unless the Board delivers to the Executive a written statement identifying all the ways in which the Board believes Cause exists under (i) and/or (ii), as applicable, and the Executive is given 30 days to cure, providing that if the Executive cures, Cause shall not exist under (i) and/or (ii), as applicable. ii. For purposes of this Agreement, “Good Reason” shall mean, without the Executive’s written consent: (i) A material diminution in the Executive’s base compensation; (ii) A material diminution in the Executive’s authority, duties, or responsibilities; (iii) A material diminution in the authority, duties, or responsibilities of the supervisor to whom the Executive is required to report, [including a requirement that the Executive report to a corporate officer or employee instead of reporting directly to the board of directors of a corporation]; (iv) A material diminution in the budget over which the Executive retains authority; (v) A material change in the geographic location at which the Executive must perform services under this Agreement; (vi) Any other action or inaction that constitutes a material breach by the Company of this Agreement or any other agreement under which the Executive provides services to the Company; [(vii) ________________________ ]. Good Reason shall not exist under (i)—([ ___ ]) above unless (A) the Executive advises the Company of the condition(s) that give rise to Good Reason within 90 days of the initial existence of the condition(s); (B) the Executive provides at least 30 days for the Company to remedy the condition(s) giving rise to Good Reason; (C) the Company has not remedied the conditions giving rise to Good Reason within the notice period; and (D) the Executive terminates his employment within two years following the initial existence of one or more of the conditions giving rise to Good Reason. 20. IRC § 409A. Each payment and benefit paid pursuant to this Agreement shall constitute a “separate payment” for purposes of Treasury Regulation § 1.409A-2(b) (2). This Agreement, and any ambiguities contained in this Agreement, shall be construed in a manner that complies with United States Internal Revenue Code (“IRC”) § 409A (“§ 409A”) and the United States Treasury Department’s implementing regulations for § 409A so that none of the payments and benefits provided under this Agreement will be subject to the additional tax imposed under § 409A. The Company and the Executive shall cooperate, in good faith, to take all reasonable actions, including amending this Agreement, which are necessary to avoid imposition of any additional tax under § 409A. 21. Specified Employee. Notwithstanding any other term in this Agreement, if, at the time of the Executive’s Separation, the Executive is a “specified employee,” as defined

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in Treasury Regulation § 1.409A-1(i), to the extent delayed commencement of any portion of the payments or benefits to which the Executive is entitled under this Agreement is required in order to avoid a prohibited distribution under 26 U.S.C. § 409A(a)(2)(B)(i), that portion of the Executive’s benefits shall not be provided to the Executive before the earlier of (a) six (6) months and one day after the Executive’s Separation, or (b) the date of the Executive’s death. All payments deferred pursuant to this section shall be paid in a lump sum to the Executive on the date which is six months and one day after the Executive’s Separation or the date of the Executive’s death, as applicable, and any remaining payments due under this Agreement shall be paid as required by this Agreement. 22. IRC § 280G. In the event that the separation and other benefits provided for in this Agreement, or otherwise payable to the Executive, constitute “parachute payments” within the meaning of IRC § 280G and will be subject to the excise tax imposed by IRC § 4999, then [ _____________________ ]. 23. Successors and Assigns. The Company may assign this Agreement to any successorin-interest to all or substantially all of its assets or business. The duties of the Executive under this Agreement are personal to the Executive and may not be assigned by Executive. 24. Severability. If any judge or arbitrator declares any provision of this Agreement invalid or unenforceable, in whole or in part, then [ _______________ ]. 25. Amendment. This Agreement may not be modified or amended, except by an agreement in writing signed by the Executive and the Company. 26. Waiver. This Agreement may not be waived, except by an agreement in writing signed by the Executive and the Company. The waiver of any term of this Agreement does not constitute a waiver of the same term at a later time, nor a waiver of any other term in this Agreement. 27. Governing Law and Venue. This Agreement shall be governed by and construed in accordance with the laws of the State of [ _________ ] without regard to [ _______ ] conflicts of laws rules. The exclusive jurisdiction and venue for all disputes arising out of or relating to this Agreement and/or the Executive’s employment with the Company shall be [ _____________ ]. 28. No Duty to Mitigate. The Executive shall have no duty to mitigate any breach by the Company of this Agreement. 29. Headings. The headings in this Agreement are for convenience only and shall not affect the meaning or interpretation of any term of this Agreement. 30. Notices. All notices and communications that are required or permitted to be given under this Agreement shall be in writing and shall be deemed given when delivered


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personally or one business day after sending, if sent by a national overnight express delivery service for next-day service. Delivery shall be made to the addresses set forth above, or to any other address specified in a notice given by one party to the other party pursuant to this section. 31. Entire Agreement. This Agreement, the SOA, Plan, CIIAA, [Change in Control Agreement] [Management Carve-Out Agreement] and Indemnification Agreement, and all agreements referenced in these agreements contain the entire agreement and understanding of the parties with respect to the Executive’s employment, and supersede and replace all prior and contemporaneous discussions, agreements, and understandings relating to the Executive’s employment. 32. Counterparts. This Agreement may be entered into by facsimile signature, or by signing, scanning, and e-mailing, and in counterparts, each of which shall be deemed an original, and all of which together shall constitute one original instrument. IN WITNESS WHEREOF, the parties signing below voluntarily enter into this Agreement:

Example of a Stock Option Grant Notice

Following is a generic sample Notice of Stock Option Grant, which may “look like” the Notice of Stock Option Grant that your Executive client will receive. ***

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Executive Employment Law NOTICE OF STOCK OPTION GRANT160

[Employee Name] [Employee Address] [City, State, Zip] The Board of Directors of Alpha-Beta-Congo, Inc. (“Company”) has granted you an option (“Option”) to purchase the number of shares of the Company’s common stock set forth below at the price per share set forth below. The Option is effective on the grant date set forth below. The Option is granted pursuant to the Company’s [ _____ ] Equity Plan (“Plan”) and is governed by the terms of the Plan, this Notice of Stock Option Grant (“Notice”), and the attached Stock Option Agreement (“SOA”). The following terms apply to your Option: Option Grant Number:

[ ___________ ]

Date of Grant:

[ ___________ ]

Type of Option:

[ ___________ ]

Exercise Price per Share:

[ ___________ ]

Number of Shares Granted:

[ ___________ ]

Vesting Commencement Date:

[ ___________ ]

Expiration Date: [ ___________ ], unless earlier terminated as provided in this Notice, the SOA, or the Plan. Vesting Schedule: [ ________________________________________ ]. By signing below, you and the Company agree that this Option is granted under and governed by the terms and conditions of the Plan, this Notice, and the SOA, and that if there is any conflict between the terms of the Plan and any other document, the terms of the Plan shall control.

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The author retains the copyright to this example.

8 DU R IN G ( A N D SOM E TIM E S BE F ORE ) T H E E M P LOY M E N T RE L ATION S HIP

§ 8.1 Change of Control, Mergers, Acquisitions, and Other Transactions

This chapter discusses some of the employment contracts that your executive or entrepreneur client may enter into during his employment relationship. They include the change in control agreement and management carve-out agreement. It is also possible that the executive or entrepreneur will sign one or more of these agreements at the commencement of his employment relationship. For example, the prospective executive may be asked to sign a change in control agreement already approved by an employer’s board of directors and previously signed by the other members of the employer’s management team. This chapter also briefly addresses the basics of negotiating for a target’s management team during a merger or acquisition. Proposed purchases of the employer almost always occur during, rather than before, employment. Chapter 8 concludes with a discussion of some of the laws that constrain the executive and entrepreneur during employment. § .. change in control agreement The change in control (or sometimes, “change of control”) agreement describes the benefits and protections the executive will receive in the event his employer undergoes a corporate change in control. Most change in control agreements will: • Define when a change of control event occurs for purposes of the agreement; 143

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• State whether benefits are earned when (or at some point after) the change of control occurs, or only if a “separation from service” happens after (or perhaps on or for some period before) the change in control event; and • List the benefits the executive will receive if the payment triggering events occur. A corporate change in control happens when those controlling the corporate governance of an employer lose control (or no longer have control) of either the governance of the corporation or the corporation’s assets.1 The following circumstances are among those that may lead to a corporate change in control: • Purchase of the controlling shares of an employer’s stock by a minority shareholder or an unrelated third party; • Replacement of a majority of the members of an employer’s board of directors with new directors not aligned with previous directors; • A sale of substantially all of the employer’s assets; • Merger of an employer with a larger entity; or • Acquisition of the employer. I.R.C. § 409A provides that deferred compensation payments may be made pursuant to a written agreement on “a change in the ownership or effective control of the corporation, or in the ownership of a substantial portion of the assets of the corporation” “to the extent provided by the Secretary [of the Treasury].”2 The treasury secretary’s implementing regulations provide: • “[A] change in the ownership of a corporation occurs [except in certain circumstances] on the date that any one person, or more than one person acting as a group . . . acquires ownership of stock of the corporation that, together with stock held by such person or group, constitutes more than 50 percent of the total fair market value or total voting power of the stock of such corporation.”3 • “[A] change in the effective control of a corporation” occurs on “[t]he date any one person, or more than one person acting as a group . . . acquires (or has acquired during the 12-month period ending on the date of the most recent acquisition by such person or persons) ownership of stock of the corporation possessing 30 percent or more of the total voting power of the stock of such corporation.”4

1

Change in control may also refer to significant dilution rather than complete loss of corporate control. 26 U.S.C. § 409A(a)(2)(A)(v). 3 Treas. Reg. § 1.409A-3(i)(5)(v)(A). 4 Treas. Reg. § 1.409A-3(i)(5)(vi)(A)(1). 2

During (and Sometimes Before) the Employment Relationship

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• “[A] change in the effective control of a corporation” occurs on “[t]he date a majority of members of the corporation’s board of directors is replaced during any 12-month period by directors whose appointment or election is not endorsed by a majority of the members of the corporation’s board of directors before the date of the appointment or election. . . .”5 • “A change in the ownership of a substantial portion of a corporation’s assets occurs on the date that any one person, or more than one person acting as a group . . . acquires (or has acquired during the 12-month period ending on the date of the most recent acquisition by such person or persons) assets from the corporation that have a total gross fair market value equal to or more than 40 percent of the total gross fair market value of all of the assets of the corporation immediately before such acquisition or acquisitions . . . .”6 When benefits are triggered solely by a change in control event, the protection is often referred to as “single trigger” protection (the only triggering event is the occurrence of the change in control). The single trigger vesting clause is the most beneficial for the executive. The employer may agree to a single trigger clause when it strongly desires to be sold, or when the executive has significant leverage and chooses to use the leverage to negotiate the provision.7 Many change in control agreements are “double trigger” agreements. In a “double trigger” change in control agreement, benefits are triggered only if the executive’s employment is terminated (usually by the employer without Cause or by the executive for Good Reason) after a change in control (and sometimes on or for some period before a change in control). The first trigger is corporate change in control; the second trigger is termination of employment. Sometimes the change in control agreement will provide for both single and double trigger benefits. This type of agreement offers benefits on a change in control and additional benefits, typically if the executive’s employment is terminated without Cause by the employer or by the executive for Good Reason, after a change in control. A corporate change in control usually means the target’s management team will no longer run the surviving entity and may lead to the premature termination of the

5

Treas. Reg. § 1.409A-3(i)(5)(vi)(A)(2). Treas. Reg. § 1.409A-3(i)(5)(vii)(A). 7 Investors in private companies often assert that a single trigger change in control acceleration clause makes it more difficult to sell the employer because potential acquirers do not want to purchase a company where the target’s management team can leave fully vested on the change in control. This concern is undoubtedly valid in certain circumstances, less valid in others. Potential acquirers sometimes offer to purchase a target company contingent on those with single trigger change in control acceleration clauses agreeing that some or all of their benefits not accelerate on the change in control or be held back after the change in control. Whether or not the single trigger change in control clause inhibits corporate transactions, as a practical matter, it may give the executive or entrepreneur a seat at the M&A negotiating table where he might otherwise not be invited (or might otherwise enjoy less leverage). 6

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target’s executives’ employment. This may cause unprotected executives to forfeit lucrative pay and equity packages. In some circumstances, the acquirer wants the target’s management team around only for as long as it takes to complete a seamless integration between the merged entities, and sometimes not even that long. The uncertainty of life in a post-changein-control world may, in turn, cause many unprotected executives to shy away from potential acquisition offers. Employers offer their management team benefits and protections in the event of a change in control to incentivize the executives to negotiate a corporate transaction in the best interest of the shareholders, but which, without the benefits, may not be in the best economic interests of the management team. Employers also offer change in control agreements to keep executives from prematurely departing (sometimes fleeing) an employer they know will be sold. From the employer’s perspective, the change in control agreement’s economic incentives align the employer’s executives’ financial interests with the interests of the employer’s shareholders.8 For their part, executives desire change in control agreements to protect themselves against the potential downsides arising from the loss of corporate control, including the risk of loss of responsibility, authority, employment, compensation, and equity. In a situation where an executive has rapidly built a successful business (and taken his job as an “equity play”), a change in control agreement also functions as a form of fairness guarantee vis-à-vis the employer’s shareholders. It does so by protecting the executive’s equity, which may still be vesting, against the specter of premature loss, where the executive has done everything possible for the stockholders, and where those stockholders have cashed out their equity interests in the company. From the executive’s perspective, the change in control agreement rewards the executive if he negotiates the sale of the employer for the benefit of the shareholders. The change in control agreement clause describing the amount and type of severance to be paid is a critical term. Severance terms differ widely from agreement to agreement. Components of severance may include base salary, expected bonuses, expected commissions, long-term incentives, COBRA premium reimbursement, company perquisites, and more. The amount of equity to be accelerated post-change in control is another critical consideration. The executive often pushes for full accelerated vesting of unvested equity, arguing that if the shareholders cash out 100 percent of their equity, the executive should have the same opportunity to do so. Employers respond differently to the full acceleration request. Many will agree to full vesting of unvested equity, but others insist on lesser amounts of accelerated vesting.

8

Theoretically, an executive’s fiduciary duty may require the executive to sell the employer when it is in the best interest of all of the shareholders to do so. Practically, however, when a management team is not looking to sell, the company probably will not be sold. The business judgment rule, discussed at greater length in § 8.2.8, affords officers and directors wide discretion to manage their companies and can usually be used to protect managers who decide not to actively seek acquirers for their employers.


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For double trigger change in control agreements, the clause describing the length of time the change in control agreement’s protections and benefits remain in force after the change in control is a critical term. The employer usually seeks a time horizon on change in control benefits. It is relatively common to preserve change in control benefits and protections for one year after the occurrence of the change in control. By contrast, the executive typically pushes for a change in control agreement providing benefits regardless of when after the transaction the termination of his employment occurs. Protection limited to one year post-change in control may leave the executive significantly exposed, particularly if he has considerable unvested equity. This may happen, for example, when an executive is on a four year vesting schedule, but builds (or turns around) the employer faster than expected and sells the company for a significant upside at the end of his second year. If, for example, the executive has $5 million in stock to vest ratably in each of the third and fourth years of his employee stock option vesting schedule, he will lose $5 million if the surviving corporate entity terminates his employment one year and one day after the corporate change in control. The change in control agreement must also include appropriate I.R.C. § 409A compliant language to ensure that its payments do not trigger excise and other taxes under § 409A. I.R.C. § 409A is discussed in greater detail in § 7.4.18.1. The change in control agreement should also address what happens in the event that payments under the agreement trigger the parachute payment and excise tax provisions of I.R.C. § 280G and § 4999. § 280G and § 4999 considerations are discussed more fully in § 7.4.21. The appendix to this chapter includes a change in control agreement. § .. management carve-out agreement The management carve-out agreement is a contract that corporate boards sometimes use to incentivize executives (and their management teams) to work for, build, and ultimately sell the employer in circumstances where the executive has little economic incentive to continue working for the employer or to sell the company. The management carve-out agreement allots (carves-out) money from the sales price of the employer for the executive (and/or his management team), thereby providing a significant bonus when the employer is sold. For example, a board may decide to pay the executive 2 percent of all sales proceeds if the employer is sold for between $50–$75 million, 3 percent of all amounts received for the sale in excess of $75 million up to $100 million, and 5 percent of all amounts received for the sale in excess of $100 million. There are a wide variety of management carve-out agreements. The size of the carve-out, the carve-out triggers, and the level of executive entitled to share in the carve-out are often the subject of negotiation between an employer’s board and the executive (or the management team). It is critical for you to recognize when the executive should negotiate for a management carve-out agreement. The need often arises at a struggling private employer with a large overhang (high liquidation preferences), where investors own preferred stock in the employer, and the executive owns (or has, via stock options, the right to acquire)

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only the employer’s common stock. The investors’ preferred stock usually carries with it certain preferences and liquidation rights, including the right to receive guaranteed payments from the sales price of the company before the common stockholders receive anything from the company’s sales price. (See § 7.3) If the preferred stockholders’ right to guaranteed payments from the employer’s sales price will consume most or all of the sales price, without a management carve-out plan, the executive may have little equity incentive to stay at, or seek the maximum sales price for, the employer. Rather, the executive who values equity will be inclined to find new employment (and a better equity play) elsewhere, whereas the executive who values salary and bonuses or commissions may have little incentive to jeopardize his job by selling the employer without a management carve-out agreement encouraging him to do so. Management teams with severely underwater stock options at public employers, where the board desires an expeditious sale of the company, are also candidates for management carve-out agreements. Armed with the knowledge the board wants to sell the employer, executives with underwater stock options and no change in control agreement may be inclined to drag their feet until they secure a perfect job somewhere else. § .. retention agreements The retention agreement is a contract that provides for a payment (usually cash or equity) in the event an employee works for the employer through a specific date or through a specific event or set of events. Retention agreements are used in a wide variety of circumstances where an employer wishes to incentivize its employees to continue working for it. For example, a retention agreement may be used in conjunction with, or instead of, a change in control agreement or management carve-out agreement to provide a financial incentive for the target’s employees to remain employed for some period of time. Alternatively, a retention agreement may be used to encourage employees to remain employed with a company that is going out of business.9 § .. negotiating for the management team during mergers and acquisitions Negotiating for a management team during an M&A transaction will test your skills as a negotiator, advisor, educator, lay psychologist, lawyer, and businessman. Significant sums of money and equity are often at stake, as is the risk that money and equity may be lost without a well-negotiated deal. M&A transactions may involve intense multiparty negotiations between parties with appreciably different interests. The acquirer

9

Bankruptcy Court approval is required before a retention payment can be made to an executive of a company in bankruptcy. 11 U.S.C. § 503(c)(1). The retention payment is limited to 10 times the average amount of similar payments paid to non-management employees in the same year, or if no similar payments are made, to no more than 25% of any similar amount paid to the executive in the prior year. Id.


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may have one set of interests, the target a separate set of interests, the target and acquirer board members a third and fourth sets of interests, the target’s investors a fifth set of interests, and the target’s management team a sixth set of interests. The target’s executives may themselves have conflicting interests and be split into two or more factions. The “management team” discussed in this chapter, and the “management team” you probably will be representing during an M&A transaction, is more likely than not only the most senior subset of the target’s executive management team. The key players on the target’s management team during the M&A negotiations will invariably be the CEO and, perhaps, the CFO, the founders, other executives with significant equity stakes in the target, and a few others who are deeply involved in the M&A discussions. As with all other negotiations, M&A negotiations have life cycles. Depending on the life cycle of the negotiation, a fast-paced multiparty negotiation may be so fluid that you are required to advise, literally, early and often. Negotiating the management team’s deal may take hours, successive all-nighters, weeks, or months. Furthermore, to optimize the result for the management team, the negotiation life cycle may leave you and your management team clients no choice but to fight hard for days or weeks knowing concessions will come only at the end and only because of the weeks of hard bargaining. Client education and client control are often necessary ingredients of the difficult multiparty M&A transaction. Business savvy is also critical. While many in business correctly believe that attorneys have a penchant for ruining deals, business savvy lawyers can save transactions that their clients might tank for all sorts of reasons, including economically irrational ones (e.g., ego, emotion). Sometimes doing what is best for your management team clients’ genuine, although perhaps buried, desire to do a deal means reading the riot act to your executive clients (or in more genteel terms, “recalibrating the management team’s expectations”). It may be necessary to tell your management team clients that the six concerns they just reeled off are completely irrelevant to the deal. On the other hand, minutes before or minutes after you bluntly explain to your clients that the deal will not get done on the unreasonable terms they are proposing, it may be necessary to advise the other side that its most recent demand is a deal breaker. The multiple competing concerns often present during an M&A negotiation may mean that, at times, the acquirer and the target (or the target’s management team) are not negotiating with each other, even though they sit face to face across the negotiating table. The acquirer-target negotiation may simply be a placeholder while other disputes are resolved. Sometimes the intensity of the battles between the target’s interest groups exceed the intensity of the negotiations between the acquirer and target. Investors, board members, and management teams may face off against each other as they argue how (or even if) to divide the equity pie. On the other hand, internecine conflicts may rack the acquirer as its constituent interests argue amongst themselves. All of this may be part of the life cycle of the negotiation. M&A transactions tend to be document heavy. You will probably spend more time commenting on documents during an M&A transaction than in almost any other

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transaction in which you represent executives or entrepreneurs. Many of the documents that are part of an M&A transaction will be very familiar. For example, there will almost surely be an employment agreement for the target’s executives. Other transaction documents, including the merger agreement, may be less familiar, although many of the key executive protection clauses they contain are discussed in this book.10 The multitude of considerations that may surface in an M&A transaction; the myriad documents that may be signed at the close of the M&A transaction; the numerous crossconsiderations, discussions, negotiations, and arguments that may arise during an M&A transaction; and how these factors affect management team negotiations during the deal far exceed the scope of this book. Moreover, learning how to negotiate for a target’s management team during an M&A transaction is, in part, a learned experience. Some basic considerations are discussed below, which should help you begin developing a management team M&A negotiating strategy. Executive Story “I think I’m about to get fired,” began Zoester, CEO of Mazin Switch Corporation (MSC). Five years before, Zoester had founded MSC with long-time friends Piper and Alex. In addition to being friends, Zoester, Piper, and Alex are business symbiotics. Zoester, a vibrant MBA, runs companies, builds sales teams, and raises money. Zoester knew little about MSC’s product (except how to sell it). Piper, a brilliant linguist and thinker, writes code. Piper served as MSC’s chief strategist and created MSC’s software. Piper’s aversion to “all the other things you have to do to make a company work” meant Piper was happy to let the others run MSC. Alex, a gifted engineer, served as MSC’s vice president of engineering and managed MSC’s overseas engineering team. Alex’s team loved their boss’s it’s-all-about-theengineering approach to life. “We just got an offer for $200 million for our company,” Zoester explained. “We want to take it. It’s a 3-X to 8-X return for our preferred investors,” Zoester said. “But our investors won’t agree to sell because they think MSC will be worth $1 billion in a few years. They claim we are not putting in the time,” the CEO spit out. “We just had another board fight, and I think the VCs are going to fire me. If they don’t fire me, I might quit anyway,” Zoester said. “OK, let’s start from the beginning,” I responded. “Tell me the capital structure . . . Tell me how many board members there are . . . Tell me what the bylaws say . . . Tell me whether you are an officer appointed by the board . . . .”

10

For details on structuring mergers and acquisition transactions, see Martin D. Ginsburg & Jack S. Levin, Mergers, Acquisitions, and Buyouts (Aspen 2010 ed.) (5 volumes).


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It took about 20 minutes of questions and answers to determine the investors did not have the votes to fire Zoester. The corporate documents guaranteed the founders 50 percent of the board seats, and further provided MSC could not be sold unless all classes of stock, voting separately, agreed to the sale. Zoester, Piper, and Alex controlled MSC’s common stock. The investors controlled each series of MSC’s preferred stock. “Because you are appointed by the board, you can only be fired by the board. Even though the investors own 75 percent of MSC, the investors don’t have control over the corporation,” I explained. “But the real question,” I continued, “is what Piper and Alex are going to do. If one of them votes to fire you, or just abstains, you’re gone. Founders often do the best and get the farthest when they stick together, but I cannot tell you how many times I have seen one founder stab another founder in the back, usually when there is lots of money on the line. At the end of the day, the duplicity often winds up hurting all the founders, but when money is involved, people do the nastiest things.” “Piper and Alex are on my side,” Zoester assured me. “We own the same number of shares, we are one hundred percent aligned, and we want you to represent all of us,” Zoester said. “So let me get this straight, you three own 25 percent of the company, and you are ready to walk away from $50 million just because you and the VCs are fighting?” I asked. “VCs ruined three of my friends’ companies. I’ll quit before that happens to me and I’ll start another company. I’ve got enough money to do that,” Zoester responded. “Let me be blunt,” I said. “How long will it take for the investors to replace you?” “I’m the MBA. They could probably replace me in a few months, but without Piper and Alex, there is no company. The entire product is in Piper’s head or written down in a language no one can understand, and the engineering team is loyal to Alex,” Zoester said. “Do the investors know that if you three walk, the company goes under?” I asked. “They definitely know the company can’t survive without Piper,” Zoester replied. “Maybe they think Alex is expendable.” “So you have a negotiation on your hands,” I said. A day later, I spoke with Piper and Alex for the first time. “I don’t trust any of the VCs. The New York VC thinks he’s king, the VC from Singapore is revoltingly passive-aggressive, but I especially don’t trust the one from London. He’s bad news,” Piper gushed with

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unremitting distaste and distrust. “I’m ready to overnight them the keys,” Alex chimed in. Hearing Piper’s and Alex’s comments confirmed for me that the founders were aligned, and I could jointly represent them. “You three can do want you want,” I said, “but I strongly suggest that you not walk away from $50 million until you see how your negotiation with the investors and acquirer goes. There’s a time and a place for everything, but the time hasn’t come for you to launch the nuclear weapon and quit. Negotiations have life cycles, and yours has just begun. Why would you give up all your hard work and your potential upside before showing the investors you are serious and seeing how things play out?” MSC’s board held multiple meetings to consider the acquisition offer. MSC’s experienced investment banking firm gave a presentation to the board, explaining the proposed deal was in the best interest of all the shareholders. The nay-saying VCs asserted the banker’s presentation was biased because the banker would be paid a contingent fee (a success fee) if the deal closed. “No reason to quit . . . there’s lots of life left in these negotiations,” I said to Zoester, Piper, and Alex, after they gave me an invective-laden account of the board fight over the banker’s presentation. “How about lunch?” queried the e-mail from investors’ counsel a few days later. During lunch, counsel agreed that the principals should meet in a room to attempt to work things out. It made no sense to allow angry parties to destroy a perfectly good company. The VCs boarded planes, and everyone met face to face a few days later. It appeared that the investors concluded that if they pushed much harder, they risked turning their investment into a zero. Shrewdly, and to the founders’ amazement, the VCs did a business mea culpa, stroking the founders’ egos and explaining they understood that the founders were MSC. The meeting took all day, but the parties were able to focus on business. Eventually, they worked out an agreement that allowed the investors a number of months to set up a win-win plan for their vision for the company. While the investors were working on their plan, the parties agreed MSC should keep the avenues of communication open with the potential acquirer. Six months later, the investors had not developed their plan, and the acquirer boosted its offer to $250 million. The board vote to sell was unanimous and genuine. At the post-deal signing party, everyone showed. One inside cynic watching the VCs shake hands talked about damage control. Another observed that it was just business. “The VCs may have pissed off the founders,” he said, “but hey, the fight was worth thirty-seven-and-a-half million more dollars to their investors.” A third onlooker remarked that if Zoester, Piper, and Alex’s next company goes as well as this one, the VCs would probably want to invest.


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§ 8.1.4.1 Basic Considerations When Negotiating for Management Teams During M&A Transactions • Much of what you need to know about negotiating the terms of the management team’s deal during an M&A transaction is discussed in this book. For the target’s management team, an M&A negotiation will almost always involve the negotiation of an executive employment agreement and confidential information and invention assignment agreement, and possibly, an executive retention agreement. The issues discussed elsewhere in this book, including, for example, the definitions of Good Reason and Cause, will often be the subject of negotiations. • Read all M&A deal documents. Clauses that affect the management team may appear in many different places in the M&A transaction documents, including the merger agreement. For example, the merger agreement may contain terms limiting the surviving entity’s indemnification obligations to the target’s executives. Identify and negotiate all clauses that may affect your management team clients, even if the terms are found in places other than the typical “executive” agreements. • Obtain Your Clients’ Chronologies. Preparation for the M&A negotiation, as with preparation for any other negotiation, should begin with an understanding of your clients’ goals. What do your management team clients want from the transaction, and what risks are they willing to take to achieve their goals? • Obtain all necessary waivers. Ethics laws in your jurisdiction may require informed written consent from all clients before you may represent multiple parties in the M&A negotiation.11 If serious potential or actual conflicts are present, executives on the management team may need separate representation. • Determine, as much as possible, the interests of all other M&A players, including the acquirer, the acquirer’s management team, key investors, key shareholders, and key board members. The more you understand about the other players’ goals, the more information your clients will have with which to negotiate. For example, determining (if possible) why the acquirer is purchasing your executive clients’ company, and as a corollary, whether the acquirer genuinely desires to retain the target’s management team, may cause the target’s management team to negotiate for terms they otherwise might not seek. • Encourage your management team clients to tell you their bottom line before the negotiation starts. Understanding your management team’s bottom line (or at least their initial bottom line) early on will assist you in negotiating the transaction and advising your clients. The management team’s initial bottom line may indeed set the bottom bar of the negotiations and inform you when

11

See Model Rules of Prof’l Conduct R. 1.7 (concurrent conflicts of interest waivable upon informed, written consent); see also Ohio Rules of Prof’l Conduct R. 1.7 (same); R.I. Rules of Prof’l Conduct R. 1.7 (same); Va. Rules of Prof’l Conduct R. 1.7 (same).

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Executive Employment Law deal breakers approach. But it also may inform you when issues that you feel will ultimately be compromised must first be negotiated hard (to satisfy the clients) and when client recalibration may be required. Knowing your management team’s early bottom line may also help you focus your clients when terms in excess of their bottom line have been secured.12

§ 8.1.4.2 The Acquirer and the Target’s Management Team The acquirer in an M&A transaction usually wants to retain the target’s management team for some period of time after the transaction. The desired retention period may be as short as (or shorter than) the time it takes to seamlessly integrate the target into the acquirer. On the other hand, the acquirer may genuinely desire to retain the target’s management team for as long as possible. Acquirers use a variety of techniques in M&A transactions to retain the target’s executives, depending on the circumstances of the acquisition and the management team’s existing employment and equity contracts. In a situation where the acquirer is assuming the target’s employees’ equity agreements, and the management team has many years to vest on very valuable stock options, the acquirer may do little more than offer the target’s executives employment agreements with comfortable salaries and bonus structures. On the other hand, where the target’s management team’s existing employment and equity agreements do not incentivize them to stay with the new entity, the acquirer may offer significant bonuses, retention agreements, or new equity grants to encourage the management team to remain with the acquirer. Alternatively, the acquirer may seek to renegotiate vesting or other terms in the management team members’ employment or equity agreements or “hold back” some of their consideration (earnings) from the deal price to ensure the management team continues to work for the acquirer for some period of time after the change in control or until a predetermined event occurs.13 § 8.1.4.2.1 Three Practical Realities The target’s management team is not always forced out. Sometimes the target’s CEO becomes the acquirer’s CEO. But the management team force-out is sufficiently common that the target’s management team should be protected against the possibility.

12

Encouraging your clients early on to reveal their bottom line may also help you determine whether there are conflicts of interest between management team members and whether you should represent all team members or suggest the executives retain separate counsel. 13 The appendix to this chapter includes excerpts from a holdback retention agreement. Renegotiated equity terms and management holdback agreements should not be confused with the merger agreement’s “indemnification holdback.” Frequently a percentage (e.g., 10–20 percent) of the acquisition sales price in a M&A transaction is held back and deposited into an escrow for a period of time (e.g., 1–2 years) to provide an easily reachable fund for the acquirer to claim against if indemnifiable claims are brought after the deal closes. Typically, the unclaimed amounts in the indemnification holdback are paid out pro rata to the target’s shareholders after the indemnification holdback retention period expires.


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While negotiating clauses into the M&A deal documents to protect your management team clients, you should keep in mind the following practical reality: A significant number of acquirers will not want your management team (or parts of your management team) to work for them for any longer than the acquirer needs to achieve a successful integration of the merged entities—and sometimes not even that long. Classically, there is a short post-change-in-control employment life expectancy for the target’s chief executive officer, chief financial officer, general counsel, chief operating officer, vice president of worldwide sales, and vice president of business development. Even when the acquirer metaphorically wants the target’s management team for the long term, and the acquirer’s M&A team says its wants the target’s management team to work forever, the acquirer’s executives (or one or more of its executives) might not see things this way three, four, or five months down the road, especially if they perceive the target’s executives as threats. The acquirer’s reasons for purchasing the management team’s employer may go a long way to predicting the post-change-in-control employment life expectancy of the target’s management team. If, for example, the acquirer purchases the target for its customers, to integrate the target’s cutting edge technology into the acquirer’s technology bundle or to shut the target down, then the target’s management team may not be needed, nor desired, long term. On the other hand, if the acquirer purchases the target to create a new stand-alone business, then the acquirer probably wants the target’s management team intact as far into the future as possible. A second practical reality: Your management team may not want to work for the acquirer for longer than it takes to vest their equity or earn other significant upside acquisition benefits. This is often the case with founders and other entrepreneurs who thrive at start-ups but look askance at more mature companies. Acquirers, of course, are acutely aware of this reality. Hence, tough negotiations often result over the terms and conditions of management retention agreements. Another practical reality: There is a significant possibility that the acquirer will mismanage the integration, including mishandling your executive clients, whose employment it may terminate for no good reason, economic or otherwise. The history of corporate mergers and acquisitions is riddled with examples of mangled integrations. Consequently, the acquirer’s genuine intent during the M&A negotiations may have little impact on reality after the close of the transaction. With respect to this third reality, the acquirer’s board would sometimes be better off post-change-in-control, from a shareholder value perspective, employing an independent consultant to tour the newly merged entity and ask each executive probing questions such as: • • • • •

Are you doing this integration the right way? What is your justification for doing the integration this way? Are you or anyone on your team acting economically irrationally? Are you letting ego get in the way? Are you concerned one or more executives from the target will replace you?

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• Do you have independent verification that you are doing the integration the correct way? • Are you the right person to manage the newly acquired group? • Are you terminating the employment of the target’s management team too early or for the wrong reasons? Generally, however, the acquirer’s executive team is free to do whatever it wants to do vis-à-vis the merged entity. This means your target management team clients should understand the practical realities of post-M&A life, so they can coldly and calculatingly decide which terms to press while negotiating their M&A transaction agreements. § 8.1.4.2.2 The Employment Agreement Cram Down M&A transactions sometimes include an attempt by one party or another to cram down employment agreements on various of the target’s executives. If you represent key senior management team members (those negotiating the deal) of a healthy target, generally you will be representing the crammers who are attempting to cram down employment agreements on their subordinate executive team members (the crammees). On the other hand, if you represent subordinate executives, your clients may be the crammees on the receiving end of an employment agreement cram down instigated by the most senior management team members. The cram down scenario develops as follows: • First, the target’s most senior executives stand to gain significant sums of money and/or significant equity as a result of the M&A transaction. • Second, the target’s most senior executives negotiate their personal employment and equity agreements, and only after they negotiate their deals do they negotiate employment and related agreements for the target’s subordinate executives. • Third, the acquirer makes the M&A transaction contingent on the target’s subordinate executives signing employment (and/or other) agreements with the acquirer. • Fourth, 12 to 96 hours before the acquirer and target are to sign the transaction documents, employment and related equity agreements are distributed to the target’s subordinate executives. • Fifth, the target’s CEO, and perhaps the target’s other most senior executives, pressure the target’s subordinate executives to sign their employment agreements. The CEO may implore the subordinate executives not to tank the transaction, which, he implies (or states), will happen if the subordinate executives refuse to sign their new employment and equity agreements. The CEO may also assure the subordinate executives that the transaction is a great deal for everyone.


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• Sixth, the target’s subordinate executives feel significant pressure to sign their new employment and equity agreements as is (or with little negotiation). They also feel a sense of loyalty to the target’s CEO and other senior executives. • Seventh, the target’s subordinate executives sign their new employment and equity agreements with little or no negotiation. A variation of this cram down scenario occurs when the management team is selling a struggling company. In this situation, the target’s most senior executives may be on the receiving end of the employment agreement cram down. This happens when the acquirer holds the employment and other related agreements of all of the target’s executives until the very last minute in an effort to pressure all of the target’s executives to sign their employment agreements with little or no negotiation. In this situation, those applying the pressure to sign the employment and related agreements may be board members or other investors who have a financial stake in closing the deal. As a practical matter, an acquirer that has spent months negotiating a transaction probably will not tank the deal because one or more executives push back during an employment agreement cram down. More likely, executives who push back during the cram down (and who the acquirer truly wants to employ post change in control) will be able to negotiate better employment agreements. Nevertheless, a significant number of executives choose not to push back during an employment agreement cram down. When you represent executives who may soon be employment agreement crammees, you should begin counseling early that an employment agreement cram down may occur. This will allow your clients time to consider their options. § 8.1.4.3 The § 280G Vote An employer may deduct an employee’s parachute payments, and the employee may avoid the 20 percent excise tax on parachute payment compensation, if the employer is a private company and if 75 percent of the company’s shareholders (not including shareholders subject to the excise tax) vote to allow parachute payments to the employee.14 The vote to approve or reject employee parachute payments is sometimes called a “280G vote.” 280G votes are relatively common when private companies are sold to public entities, especially when management team members (and possibly others) will receive accelerated vesting and significant severance on the close of the change in control transaction. The employee is not required to participate in the 280G vote, although an acquirer may make a transaction contingent on the target holding a 280G vote. A 280G vote requires the employee to agree to forfeit all parachute payments (all compensation in excess of 2.99 times the employee’s base earnings amount) in the event the 280G vote fails.15 Consequently, if the employee participates in a 280G vote,

14 15

26 U.S.C. § 280G(b)(5)(B)(i). Parachute payments are discussed in greater detail in § 7.4.21. Treas. Reg. § 1.280G-1, Q&A 7(b).

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the employee may risk losing significant benefits that he would otherwise receive, albeit subject to a 20 percent excise tax. Most 280G votes are held and passed without much ado. Yet, the potential of forfeiting their parachute payments has caused many founders significant anxiety, especially in situations where the founders and board members or investors have been fighting. For example, in a situation where a founder will earn $10 million in parachute payments as the result of selling his company, and at the same time, the founder distrusts investors holding 40 percent of the company’s shares, the founder must decide whether to put his $10 million at risk in the 280G vote or pay additional taxes on the $10 million. If the founder is in the 50 percent combined state and federal tax bracket, the difference in take-home pay for the founder if the 280G vote succeeds (as compared to not holding a 280G vote) is $5 million vs. $3 million. But if the 280G vote fails, the founder takes home neither $5 million nor $3 million. § 8.1.4.4 The Non-Binding Dodd-Frank § 951(b) Vote § 951(b) of Dodd-Frank requires a public employer that is being acquired (a public company target) to hold a non-binding shareholder vote on whether or not the target’s NEOs should receive merger-related change in control benefits.16 When a public employer’s shareholders are “asked to approve an acquisition, merger, consolidation, or proposed sale or other disposition of all or substantially all of the assets of [the employer],” the employer must include “in a clear and simple form” in the shareholder proxy or other solicitation materials a description of all agreements and understandings with its NEOs “concerning any type of compensation (whether present, deferred, or contingent) that is based on or otherwise relates to the [merger or acquisition activity].”17 The company must also disclose the “aggregate total of all such compensation . . . that may be paid or become payable to [its NEOs].”18

16

(Securities Exchange Act of 1934 § 14A(b)(1)). The vote is not required if the shareholders have previously approved the merger-related change in control benefits. Dodd-Frank § 951 (Securities Exchange Act of 1934 § 14A(b)(2)). Under Dodd-Frank, the non-binding vote does not affect the board’s fiduciary duties. § 951 (Securities Exchange Act of 1934 § 14A(c)). It is unclear whether state courts interpreting state fiduciary law will reach the same conclusion. See § 8.2.8 for a discussion of the business judgment rule and directors’ fiduciary obligations. 17 Dodd-Frank § 951 (Securities Exchange Act of 1934 § 14A(b)(1)). 18 Id. Dodd-Frank charges the SEC with issuing regulations to define “clear and simple form[s]” of disclosure. Id. Dodd-Frank permits the SEC to exempt classes of public employers from § 951(b)’s requirements. (Securities Exchange Act of 1934 § 14A(e)). The SEC adopted implementing regulations on January 25, 2011. See Shareholder Approval of Executive Compensation and Golden Parachute Compensation, Securities Act Release No. 33-9178, Exchange Act Release No. 34-63768 (Jan. 25, 2011), available at http://www.sec.gov/rules/final/2011/33-9178.pdf.


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§ 8.2 Legal Constraints on Employment Negotiations

This section contains a brief and select description of various laws that may impact the executive’s or entrepreneur’s employment relationship while the executive or entrepreneur is employed. This section is by no means comprehensive but rather serves as an alert to issues that may require further analysis (and legal research), depending on the executive’s or entrepreneur’s particular situation. § .. public company public reporting obligations Public companies cannot pay their most senior officers in “secret.” Public employers are required to publicly disclose the compensation of their directors and Named Executive Officers.19 The compensation information is provided in the public company’s yearly proxy statement.20 Disclosure of compensation is broken down by base salary and bonus and equity compensation. Public employers are also required to include a section in their proxies labeled, “Compensation, Discussion and Analysis.” In the CD&A section, public employers explain all material elements of their executive compensation programs.21 Public companies are also required to publicly disclose key agreements that their NEOs enter into, including employment and severance agreements, change in control agreements, management carve-out agreements, and indemnification agreements.22 Public companies are further required to promptly disclose material changes in their NEOs and in NEO compensation structures.23 They usually do this by filing 8-K disclosures with the SEC.24 Directors and § 16 reporting executive officers25 are also required to file public disclosures on SEC Form 5 stating the equity interest the reporting individual has in his company.26 These same directors and § 16 executive officers must also report purchases and sales of company equity on SEC Form 4.27 Many public employers have stock

19

SEC Reg. S-K, Item 402, 17 C.F.R. § 229.402(a)(2)-(3). See § 7.1.5 for an additional discussion of a public company’s disclosure obligations. 20 SEC Sched. 14A, Item 8, 17 C.F.R. § 240.14a-101; SEC Reg S-K, Item 402, 17 C.F.R. § 229.402(b). 21 17 C.F.R. 229.402(b). 22 SEC. Regulation S-K, Item 402, 17 C.F.R. § 229.402(a)(2), (a)(6)(ii), (b). 23 SEC. Rule 13a-11, 17 C.F.R. § 240.13a-11; SEC. Rule 15d-11, 17 C.F.R. § 240.15d-11; SEC. Form 8-K, Item 5.02(e)–(f), 17 C.F.R. § 249.308. 24 See SEC Form 8-K, Item 5.02(e)–(f), 17 C.F.R. § 249.308. 25 Those required to report under Section 16 with respect to a public company include directors and certain officers of the company as well as beneficial owners of more than 10 percent of any class of security in the company. 15 U.S.C. § 78p(a)(1). 26 15 U.S.C. § 78p(a)(3); 17 C.F.R. § 249.105. 27 17 C.F.R. § 249.104.

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departments, or specifically tasked in-house attorneys, to ensure company executives promptly file all required SEC documents.28 § .. i.r.c. § (m) I.R.C. § 162(m) limits the amount of cash compensation a public corporation may deduct as a business expense for covered employees. The limit is $1,000,000 per year per covered executive.29 Performance-based compensation that satisfies certain requirements is not included in the limit.30 Similarly, stock options and other equity compensation, in most circumstances, are not included in the limit.31 § .. sarbanes-oxley limits The Sarbanes-Oxley Act of 2002 and its implementing regulations are stringent, detailed, and extensive. The SEC’s Web site lists no less than 19 final rule makings issued pursuant to Sarbanes-Oxley.32 While an employer’s corporate lawyers typically focus on compliance with all securities law, including Sarbanes-Oxley, it is important to have some understanding of how Sarbanes-Oxley may affect your executive’s employment negotiations and his general “business life.” Sarbanes-Oxley contains many requirements and restrictions directly affecting public company executives. For example, § 302 of Sarbanes-Oxley requires CEOs and CFOs to certify the accuracy of the financial statements (e.g., 10-Ks and 10-Qs) their employer files with the SEC.33 As a second example, in the event a public employer is required to restate its financial statements, § 304 of Sarbanes-Oxley requires the company’s CEO and CFO to forfeit back to the employer all bonuses and incentive pay, as well as profits from selling the employer’s securities, that were received during the one-year period after the date the employer filed the offending financial statements.34

28

The SEC’s executive disclosure rules are detailed. For guidance in this area, see Mark A. Borges, SEC Executive Compensation Disclosure Rules (ABA 2008). 29 26 U.S.C. § 162(m). Executives covered by the § 162(m) limits are the employer’s CEO, CFO, and its three highest-paid executive officers other than the CEO and CFO. 26 U.S.C. § 162(m)(3); 17 C.F.R. § 229.402(a). The deductibility limit is less for executives of companies selling assets in the Troubled Asset Relief Program. See § 8.2.7. Under The Patient Protection and Affordable Care Act, beginning on January 1, 2013, the deductibility limit for cash compensation earned by directors, executives, and certain employees of covered health insurers will be $500,000 per year per employee, although certain permitted deferrals may affect the limit. 26 U.S.C. § 162(m)(6). 30 26 U.S.C. § 162(m)(4)(C). 31 26 U.S.C. § 162(m)(4)(E)(ii). 32 See Securities & Exchange Commission, Spotlight on: Sarbanes-Oxley Rulemaking and Reports, www.sec. gov/spotlight/sarbanes-oxley.htm (last modified Sep. 16, 2005). 33 Codified at 15 U.S.C. § 7241. 34 Codified at 15 U.S.C. § 7243.


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Sarbanes-Oxley also changed certain former, “more or less standard” employerexecutive practices. For example, pre-Sarbanes-Oxley, employers would often “lend” money to their executives at very favorable interest rates and with very favorable (or no) repayment terms. Section 402(a) of Sarbanes-Oxley ended this practice for public companies by making corporate loans to directors or officers of the company illegal, except in certain limited circumstances (e.g., a company in the business of providing loans, such as mortgages, in the ordinary course of its business, may offer loans to its officers and directors on the same terms it extends to the public).35 This change for public employers immediately trickled down to private employers hoping to go public or sell themselves to public companies. While private employers may legally provide sweetheart loans to their officers and directors, as a practical matter, many refuse to do so because they must forgive (or immediately call) the loans if the employer goes public or is sold to a public company.36 § .. securities laws and sec regulations § 8.2.4.1 Securities Law Restrictions In addition to Sarbanes-Oxley, there are numerous securities laws and regulations that may directly or indirectly affect your executive client’s working life. These include the Securities Act of 1933,37 Securities Exchange Act of 1934,38 Trust Indenture Act of 1939,39 Investment Company Act of 1940,40 and Investment Advisers Act of 1940.41 For each Act, the SEC has established implementing regulations that are also the law of the land.42 For the most part, you will not be required to know the ins and outs of every securities regulation, nor would any reasonable executive client expect this of you. Many of the regulations will not affect most (or any) of your clients. Others may affect them in multiple ways, but via the manner in which they do their jobs and thus are the province of corporate counsel. Nevertheless, the more you have a feel for the way the securities laws may impact the executive, the more you will have a sense of your executive’s playing field, and the better all around advisor you will be. Knowing what questions to ask, and knowing

35

Codified at 15 U.S.C. § 78m(k)(1)–(2). Id. (“It shall be unlawful for any issuer . . . to extend or maintain credit. . . in the form of a personal loan to or for any director or executive officer (or equivalent thereof) of that issuer [emphasis added].”) “Issuer” means “any person who issues or proposes to issue any security” on a national securities exchange or applies to do so. 15 U.S.C. §§ 78m(k)(1), 7201(7), 78c(a)(8), 78l(a). 37 Securities Act of 1933, 15 U.S.C. § 77a, et seq.; 17 C.F.R. pt. 230. 38 Securities Exchange Act of 1934, 15 U.S.C. § 78a, et seq.; 17 C.F.R. pt. 240. 39 Trust Indenture Act of 1939, 15 U.S.C. § 77aaa, et seq.; 17 C.F.R. pt. 260. 40 Investment Company Act of 1940, 15 U.S.C. § 80a-1, et seq.; 17 C.F.R. pt. 270. 41 Investment Advisers Act of 1940, 15 U.S.C. § 80b-1, et seq.; 17 C.F.R. pt. 275. 42 See the SEC’s Web site at www.sec.gov. For a one-volume treatise on U. S. securities laws, see Gary M. Brown, Soderquist on the Securities Laws (PLI, 5th ed. 2006 & Supp. 2010). 36

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what you do not know, are both valuable. So, too, is knowing when to advise your client that he must obtain a legal opinion from corporate (or independent securities) counsel before moving forward on an idea about which he has consulted you. There are certain securities laws you must understand to effectively advise executives and entrepreneurs. Principal among these are the prohibitions against insider trading and committing securities fraud, found in § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 of the SEC’s implementing regulations.43 These rules prohibit executives from misleading the public markets (deceiving shareholders) about material events involving their employer and its prospects. These securities laws also make it illegal for an employee to purchase or sell an employer’s securities on the public markets when the employee is in possession of “material non-public information” about the employer. It is not always easy to determine what information qualifies as “material non-public information.” Certain information is clearly material, non-public information. For example, the knowledge that in two days the employer will disclose financial results showing it is insolvent, when the employer has previously publicly maintained it is as strong as Fort Knox, undoubtedly qualifies as material non-public information. If the employer’s CEO sells all of his stock in his employer two days before the announcement or tips others to sell their stock, then he may wind up in jail (and fired for cause, required to disgorge his ill gotten gains and prohibited from ever running another public company).44 On the other hand, the executive’s gut feeling that a miracle will deliver revenues exceeding one hundred thousand times his employer’s current revenues within three years almost certainly does not qualify as material non-public information.

43

17 C.F.R. § 240.10b-5. 15 U.S.C. § 78j. SEC Rule 10b-5 states:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) To engage in any act, practice, or course of business which operates, or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. 44 15 U.S.C. § 78ff(a) provides criminal penalties for willful violations of 10b-5. See, e.g., U.S. v. Blackwell, 459 F.3d 739 (6th Cir. 2006) (affirming 72-month sentence). Multiple code sections provide for disgorgement of profits or reliance damages. 15 U.S.C. §§ 78u, 78u-1 (providing for penalties of up to three times profits received); 15 U.S.C. §§ 78r(a), 78t-1 (providing for reliance damages for false or misleading statements), see SEC. v. World Information Technology, Inc., 590 F.Supp.2d 574 (S.D.N.Y. 2008) (requiring disgorgement of profits plus interest). 15 U.S.C. § 78u(d)(2) provides courts with the authority to prohibit persons from serving as officers or directors of public companies. See, e.g., SEC. v. First Pacific Bancorp, 142 F.3d 1186, 1193–94 (9th Cir. 1998) (district court has wide discretion to bar individuals from serving as officers or directors of public companies).


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The problem: there is a very wide and very gray area in between these two extreme examples, where courts disagree about what constitutes “material non-public information.” There are legions of court cases on this issue.45 If you are called on to determine whether information is “material” under the securities laws, unless you double as a securities lawyer, a securities law expert should be called on to render the opinion. Many public companies have “securities trading policies” that prohibit employees from buying or selling company securities under certain conditions. The policies frequently provide a securities law primer to their employees. Many public companies also impose a blanket “trading blackout” on key decision makers during certain parts of the year (for example, some employers prohibit their executives from trading company securities in the last month of the quarter and in the first month of the new quarter until three days after the employer announces its financial results for the prior quarter). These blackouts are in addition to blackouts imposed when the employer believes the executive is, or may be, in possession of material non-public information. § 8.2.4.2 10b5–1 Trading Plans Some public employers permit their executives to adopt 10b5–1 trading plans (or enter into binding contracts) to sell company stock the executive owns, or will own, after exercising an employee stock option. Executives use 10b5–1 trading plans to sell their stock at regular intervals while avoiding potential claims of illegal insider trading. This permits executives with concentrated holdings in their employers to diversify their assets. The company stock is sold according to predetermined instructions, formulas, algorithms, or computer programs.46 10b5–1 trading plans are authorized by the SEC

45

For cases on materiality, see TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976) (“[a]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote” and there is a “substantial likelihood” that disclosure would have “significantly altered the ‘total mix’ of information made available”); see also Basic, Inc. v. Levinson, 485 U.S. 224 (1988); Day v. Staples, Inc., 555 F.3d 42 (1st Cir. 2009); Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., 553 F.3d 187 (2d Cir. 2009); Zaluski v. United American Healthcare Corp., 527 F.3d 564 (6th Cir. 2008); SEC. v. Talbot, 530 F.3d 1085 (9th Cir. 2008); No. 84 EmployerTeamster Joint Council Pension Trust Fund v. America West Holding Corp., 320 F.3d 920 (9th Cir. 2003) (immediate market reaction upon disclosure of facts not required); Ganino v. Citizens Utilities Co., 228 F.3d 154 (2d Cir. 2000) (information that is trivial or so basic that any investor could be expected to know it may not be material). For cases on non-public information, see SEC. v. Mayhew, 121 F.3d 44, 50 (2d Cir. 1997) (information remains non-public until being disseminated in a manner sufficient to insure its availability to the investing public or to insure the market has absorbed the disclosed information, so that company’s stock price has adjusted to reflect the information); U.S. v. Royer, 549 F.3d 886 (2d Cir. 2008); U.S. v. O’Hagan, 139 F.3d 641, 648 (8th Cir. 1998) (where investor had “firsthand, concrete knowledge” of an impending corporate takeover while the investing public received only speculative reports of a potential takeover, information about the takeover was “non-public” information, and trading on the “non-public” information created liability for securities fraud). 46 17 C.F.R. § 240.10b5–1(c)(1). An executive may also instruct another person to sell the stock for the executive’s account. 17 C.F.R. § 240.10b5–1(c)(1)(i). 10b5–1 trading plans may also be used to purchase an employer’s stock. Id.

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and provide an affirmative defense to allegations of illegal insider trading where (1) a binding trading plan is instituted before the executive becomes aware of the material non-public information; (2) the trading plan is entered into in good faith and not for the purposes of evading the securities laws; (3) the trading plan allows the executive no “subsequent influence over how, when, or whether” the purchase or sale will occur; and (4) the stock sale occurs pursuant to the plan.47 A 10b5–1 trading plan must contain specific instructions (e.g., sell 10,000 shares of stock on the 15th day of each calendar quarter), a formula (e.g., if the stock price is above $10/share on the first day of the calendar quarter, then on that day sell 3 percent of executive’s stock in the employer, but if the stock price is above $20/share, then on that day sell 5 percent of executive’s stock in the employer), an algorithm, or a computer program.48 The plan’s instructions, formula, algorithm, or computer program must set or determine the amount of stock to be sold, the price at which the stock will be sold, and the date(s) for the sale(s).49 The executive must have no discretion in these areas.50 The idea behind 10b5–1 trading plans: By selling according to a predetermined plan, the executive does not sell stock “‘on the basis of’ material non-public information,” even if he is in possession of material non-public information about his employer.51 If the executive deviates from the predetermined 10b5–1 plan while selling his employer’s stock, he loses the benefit of the affirmative defense and may be found liable for illegal insider trading.52 The SEC’s staff takes the position that an executive may cancel a 10b5–1 trading plan at any time, including when he possesses material non-public information about his employer.53 The ability to terminate a 10b5–1 plan at any time allows the executive to cancel his plan when he possesses information about his employer that he knows will cause the price of the company’s stock to drop. By doing so, the executive may avoid selling stock at depressed prices. On the other hand, the SEC’s staff has also taken the position that cancelling a 10b5–1 trading plan while in possession of material non-public information may call into question whether the plan was entered into in “good faith.”54 If it was not, then the affirmative defense is lost, and the executive may be liable for illegal insider trading.55

47

17 C.F.R. § 240.10b5–1(c)(1). 17 C.F.R. § 240.10b5–1(c)(1)(i)(B). 49 Id. 50 17 C.F.R. § 240.10b5–1(c)(1)(i)(C). 51 § 7.4.18.6.5 discusses adding anti-blackout language into executive employment agreements. 52 17 C.F.R. § 240.10b5–1(c)(1)(i)(C). 53 SEC Division of Corporate Finance, Manual of Publicly Available Telephone Interpretations, Rule 10b5–1 Q&A 15(a) (June 8, 2001), available at www.sec.gov/interps/telephone/phonesupplement4.htm. 54 SEC Division of Corporate Finance, Manual of Publicly Available Telephone Interpretations, Rule 10b5–1 Q&A 15(b) (June 8, 2001), available at www.sec.gov/interps/telephone/phonesupplement4.htm. 55 Id.; 17 C.F.R. § 240.10b5–1(c)(1)(ii). 48


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The 10b5–1 plan may be publicly disclosed. If it is, the trading plan may reduce the employer’s concern that the stock market will view the executive’s stock sale as a harbinger of bad things to come. The employer hopes that market watchers and participants view the executive’s trading plan–driven sales as part of a regular process unrelated to company events. Executive Story After many very successful years as chief operating officer of a public company, Xerxes decided to retire. At Xerxes’s going-away party, Xerxes received a gold watch from his employer. His colleagues pitched in for a pair of around-the-world tickets and vouchers for stays in some of the world’s nicest hotels. Xerxes’s last day of employment was the end of the fiscal quarter. His ex-employer announced its financial results for that quarter about 20 days later. Xerxes had millions of dollars of vested employee stock options and wanted to diversify. Three days after the ex-employer announced its financial results, Xerxes attempted to exercise almost all of his stock options and sell all of his stock on the public market. Initially, the ex-employer refused to allow Xerxes to sell his stock. The company took the position that Xerxes must be in possession of material non-public information because he had been a key member of its management team. However, the company’s financial results had just been announced, and Xerxes did not know anything about the next quarter’s financial results because the quarter had not begun before his last day of employment. The employer was not planning a product launch, and there were no acquisitions or other material events on the employer’s calendar, other than Xerxes’s departure, which had already been disclosed to the market. It appeared that the ex-employer did not want Xerxes “dumping” his stock so soon after leaving because it might send the “wrong” signal to the market. But an exemployer’s desires do not necessarily correlate with permitted conduct under the securities law. In Xerxes’s situation, they did not. During conversations with the employer’s securities counsel, Xerxes’s counsel respectfully explained that Xerxes had no material non-public information about the company, that Xerxes was legally permitted to sell his stock, and that the ex-employer’s refusal to allow him to sell his stock would be wrongful and make the employer the insurer for any losses Xerxes incurred as a result of the company-imposed blackout. Thereupon, a lively discussion about federal securities laws ensued. The discussion ended with the ex-employer’s securities counsel saying he would think about it. Two days later, Xerxes’s ex-employer relented. Thereafter, Xerxes sold his stock.

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§ ... §  short swing profits Section 16(a) of the Securities Exchange Act56 prohibits § 16 reporting executives from making a profit on the purchase and sale of an employer’s stock on the public markets during a six-month period.57 For example, the executive cannot buy 1,000 shares of his employer’s stock on January 1st at $10/share and sell that stock for $50 share on April 1st of the same year. The $40,000 gain is an illegal “short swing” profit and must be paid to the employer. The short swing profits rule is a strict liability rule and cannot be explained away.58 Either it is violated, or it is not.59 § .. foreign corrupt practices act The Foreign Corrupt Practices Act of 1977 (FCPA)60 applies to United States employers and Americans doing business in foreign countries. “In general, the FCPA prohibits corrupt payments to foreign officials for the purpose of obtaining or keeping business. In addition other statutes, such as the mail and wire fraud statutes . . . and the Travel Act . . . which provide for federal prosecution of violations of state commercial bribery statutes, may also apply to such conduct.”61 The FCPA’s prohibitions apply to both the employer and the executive.62 Violations of the FCPA may lead to civil enforcement proceedings or criminal prosecution.63 Some U.S.-based employers doing business abroad have FCPA policies in the same way they have securities trading policies. These employers may require their executives to sign an acknowledgment that they have read and will abide by the applicable FCPA policy. The prospective executive should review the policy before joining the employer.

56

15 U.S.C. § 78p. 15 U.S.C. § 78p(b). 58 Id.; Reliance Elec. Co. v. Emerson Elec. Co., 404 U.S. 418, 422 (1972) (“The objective standard of Section 16(b) imposes strict liability upon substantially all transactions occurring within the statutory time period, regardless of the intent of the insider or the existence of actual speculation.”) (quotation omitted). 59 Id. 60 15 U.S.C. §§ 78dd-1, et seq. 61 Department of Justice, Lay Person’s Guide to the Foreign Corrupt Practices Act, www.justice.gov/ criminal/fraud/fcpa/docs/lay-persons-guide.pdf (last revised May 7, 2010). The mail and wire fraud statutes are codified at 18 U.S.C. §§ 1342–1343. The Travel Act is codified at 18 U.S.C. § 1952. 62 15 U.S.C., 166 n. 62 (prohibiting certain activities “for any issuer . . . or for any officer, director, employee, or agent of such issuer or any stockholder thereof acting on behalf of such issuer . . . .”). 63 See Lay Person’s Guide, footnote 61, at 5. 57


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§ .. a short list of other federal laws applicable in employment Following is a non-exhaustive list of various federal laws that apply directly to the executive in employment and/or regulate the conduct of the executive toward others while on the job (presuming the employer is sufficiently large to be covered by the statute). • The Fair Labor Standards Act of 1938 sets minimum wage, overtime, record keeping, and youth employment standards for employers engaged in interstate commerce.64 • Under the Employee Retirement Income Security Act of 1974, it is illegal to deny ERISA benefits to qualifying employees and to discriminate against an employee because he has brought an ERISA claim.65 • Under the Worker Adjustment and Retraining Notification Act, employers must provide 60 days advance notice before a mass layoff, including those pursuant to a merger, plant closing, or severe reductions in hours.66 • Under Title VII of the Civil Rights Act of 1964 and the Civil Rights Act of 1991, it is illegal to discriminate on the basis of race, color, sex, religion, or national origin in the workplace, including while hiring or terminating employees.67 • Under the Age Discrimination in Employment Act of 196768 and the Older Workers Benefit Protection Act,69 it is illegal to discriminate in employment against an employee 40 years of age or older because of the employee’s age. • Under the Americans with Disabilities Act of 1990, it is illegal to discriminate against an employee because the employee is disabled.70 • Under the Rehabilitation Act of 1973, federal agencies and employers with federal contracts or subcontracts worth more than $10,000 are required to take affirmative steps to employ disabled individuals.71 • Under the Family and Medical Leave Act of 1993, employers must give employees, in any 12-month period, up to 12 weeks of unpaid leave to care for new or

64

29 U.S.C. §§ 201, et seq.; see also U.S. Department of Labor, Wage and Hour Division Web site, www.dol. gov/whd/flsa/index.htm. 65 29 U.S.C. § 1053 (minimum vesting standards); 29 U.S.C. §§ 1140–1141 (antidiscrimination provisions); see also U.S. Department of Labor, Compliance Assistance, www.dol.gov/ebsa/compliance_assistance. html. 66 29 U.S.C. § 2102(a); see also U.S. Department of Labor, The Worker Adjustment and Retraining Notification Act (WARN), www.dol.gov/compliance/laws/comp-warn.htm. 67 Civil Rights Act of 1964, 42 U.S.C. §§ 2000e, et seq.; Civil Rights Act of 1991, 29 U.S.C. §§ 626, 630, 42 U.S.C. §§ 1981, 2000e, et seq. 68 Age Discrimination in Employment Act of 1967, 29 U.S.C. §§ 621–634; see also 29 C.F.R. pts. 1625–26. 69 Older Workers Benefit Protection Act, 29 U.S.C. §§ 621, 623, 626, 628, 630. 70 Americans with Disabilities Act of 1990, 42 U.S.C. §§ 12101, et seq., 47 U.S.C. § 225. 71 Rehabilitation Act of 1973, 29 U.S.C. § 701 et seq.; see also 41 C.F.R. §§ 60–741 to 60–742.

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•

•

• •

Executive Employment Law adopted children or to address the serious health conditions of either immediate family members or themselves.72 Under the whistleblower protection provision of the Occupational Safety and Health Act of 1970 (OSHA), it is illegal to discharge or discriminate against employees who have filed an OSHA complaint or caused an OSHA proceeding.73 Under the whistleblower protection clause of Dodd-Frank, it is illegal to discriminate against employees for reporting an employer’s financial wrongdoing to the SEC and collecting a bounty for providing the information.74 Under the Equal Pay Act of 1963, it is illegal to pay a female employee less than a similarly situated male employee who performs the same work.75 Under the Uniformed Services Employment and Reemployment Rights Act of 1994, it is illegal to discriminate against an individual because he has served in the United States military.76

States differ widely on the laws they impose in the workplace. Consequently, a thorough understanding of the state law applicable to the executive’s employment is also a must. § .. bailout act and related restrictions The Emergency Economic Stabilization Act of 2008,77 as amended by the American Recovery and Reinvestment Act of 200978 and implementing Treasury Department regulations,79 limit executive pay at those companies selling assets in the Troubled Asset Relief Program, including those selling preferred stock to the government as part of the Capital Purchase Program (CPP).80 If you represent executives from one of the institutions involved in the TARP program, then you must review all current regulations affecting these companies and

72

Family and Medical Leave Act of 1993, 29 U.S.C. §§ 2601, et seq.; see also 29 C.F.R. pt. 825; U.S. Department of Labor, Family and Medical Leave Act, www.dol.gov/whd/fmla. 73 29 U.S.C. § 660(c). 74 §§ 922-924. Dodd-Frank added the whistleblower protection clause as § 21E of the Securities Exchange Act of 1934, 15 U.S.C. § 78a, et seq. §§ 748-749 of Dodd-Frank added a similar whistleblower protection clause to the Commodity Exchange Act (CEA) for wrongdoing reported by employees under the CEA, 7 U.S.C. § 1, et seq. 75 Equal Pay Act of 1963, 29 U.S.C. §§ 206, 209, 211, 213, 215–19, 255–56, 259–60, 262; see also 29 C.F.R. pts. 1620–21. 76 Uniformed Services Employment and Reemployment Rights Act of 1994, 38 U.S.C. §§ 4301–4333. 77 Pub. L. No. 110–343, 122 Stat. 3765. 78 Pub. L. No. 111–5, 123 Stat. 115. 79 TARP Standards for Compensation and Corporate Governance, 31 C.F.R. pt. 30. 80 See U.S. Department of the Treasury, Treasury Announces TARP Capital Purchase Program Description, Treas. News Release HP-1207 (Oct. 14, 2008), available at www.treasury.gov/press-center/press-releases/ Pages/hp1207.aspx.


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executives. A host of new rules affect only them.81 For example, the limit for deductible compensation is reduced to $500,000 per year (regardless of what year the income is deferred into), with no exclusion for performance-based compensation.82 Rules have also limited parachute payments to TARP executives in a change in control to 2.99 times the executive’s five-year average base compensation.83 The bailout legislation established an Office of the Special Master for Executive Compensation in the Treasury Department.84 The special master’s responsibility is to oversee executive compensation at the TARP-participating institutions. Kenneth R. Feinberg was appointed as the first special master. Beginning in October 2009, the special master issued detailed rules and compensation limits at the affected institutions. Copies of the letters that the special master sent to each of the financial institutions with his executive compensation rulings can be found at www.financialstability.gov/ about/executivecompensation.html. This Web site also contains a link to the Treasury Department’s applicable Interim Final Rule. § .. business judgment rule It is not illegal for an employer to make foolish and economically irrational decisions regarding its executives. The federal bankruptcy courts are full of companies that ran themselves into the ground for one reason or another. Directors and officers are constrained in their decision making only by the fiduciary duties they owe their company and its shareholders. Two important fiduciary duties normally owed are the duty of care and the duty of loyalty. The duty of care typically requires that when making business decisions, a director or officer use the amount of care that an ordinarily careful and prudent man would use in similar circumstances.85

81

See Emergency Economic Stabilization Act of 2008 (EESA) (codified at 12 U.S.C. § 5221, 26 U.S.C. § 162(m) (5)) (authorizing treasury secretary to regulate compensation and incentives, reducing limits for tax deductions, and expanding golden parachute rules); American Recovery and Reinvestment Act of 2009 (ARRA) (codified at 12 U.S.C. § 5221) (prohibiting payment of certain golden parachutes, bonuses, retention awards, incentive compensation, and luxury expenditures, requiring CEOs and CFOs to certify compliance; establishing Board Compensation Committees; and requiring the treasury secretary to take other precautions); 31 C.F.R. pt. 30 (treasury regulations detailing requirements for compliance with EESA and ARRA). 82 26 U.S.C. § 162(m)(5). 83 12 U.S.C. § 5221(b)(3)(C); see also 31 C.F.R. §§ 30.1, 30.9. 84 31 C.F.R. § 30.16. 85 In re The Walt Disney Co. Derivative Litig., 907 A.2d 693, 749 (Del. Ch. 2005) aff ’d, 906 A.2d 27 (Del. 2006) (Duty of care requires director or officer to “use that amount of care which ordinarily careful and prudent men would use in similar circumstances” and “consider all material information reasonably available in making business decisions”) (citations and quotations omitted); Storetrax v. Gurland, 895 A.2d 355, 374 (Md. Ct. Spec. App. 2006) (“[A] director shall perform his duties . . . in a manner he reasonably believes to be in the best interests of the corporation” and “with the care that an ordinary prudent person in like position would use under similar circumstances”) (citation and quotations omitted); Stamp v. Touche Ross & Co., 636 N.E.2d 616, 620 (Ill. App. Ct. 1993) (“[D]irectors must exercise in the

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The duty of loyalty classically requires that a director or officer put the best interests of the corporation and all of its shareholders first when making business decisions and before the interests of any director, officer, or controlling shareholder that are not shared by all stockholders.86 The business judgment rule presumes that directors and officers satisfy their fiduciary obligations when they act on behalf of the corporation. The “law presumes that in making a business decision the directors [and officers] of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interest of the company.”87 By presuming that directors and officers act in good faith, the business judgment rule gives an employer’s directors and officers very wide discretion to manage their company and make the employment-related decisions they want to make. For Delaware corporations, the discretion is almost unfettered if an employer’s board of directors relies in its decision-making process on an independent executive compensation expert.88 A disinterested board of directors of a Delaware corporation can breach its fiduciary duty if it “wastes” corporate assets. In Delaware, to show “waste,” a complaining party must demonstrate that “no reasonable business person would have made the decision” under the circumstances faced by the decision maker.89 This is nearly impossible for a

management of corporate affairs the degree of care which prudent men, prompted by self-interest, would exercise in the management of their own affairs”). 86 In re The Walt Disney Co. Derivative Litig., 907 A.2d 693, 751 (Del. Ch. 2005) (Duty of loyalty requires director or officer to put “the best interest of the corporation and its shareholders . . . over any interest possessed by a director, officer, or controlling shareholder and not shared by the stockholders generally”) (citation and quotation omitted); Higgins v. New York Stock Exchange, Inc., 806 N.Y.S.2d 339, 357 (N.Y. Sup. Ct. 2005) (Duty of loyalty requires director or officer “not to assume and engage in the promotion of personal interests which are incompatible with the superior interests of their corporation” or to “profit personally at the expense of the corporation”) (citation and quotations omitted); Shoen v. SAC Holding Corp., 137 P.3d 1171, 1178 (Nev. 2006) (“[T]he duty of loyalty requires the board and its directors to maintain, in good faith, the corporation’s and its shareholders’ best interests over anyone else’s interests”). 87 In re The Walt Disney Co. Derivative Litig., 906 A.2d 27, 52 (Del. 2006) (citation and quotation omitted); accord Behradrezaee v. Dashtara, 910 A.2d 349, 361 (D.C. 2006); Willmschen v. Trinity Lakes Improvement Ass’n, 840 N.E.2d 1275, 1279 (Ill. App. Ct. 2005); Kansas Heart Hospital, LLC v. Idbeis, 184 P.3d 866, 885 (Kan. 2008); Sadler v. Jorad, Inc., 680 N.W.2d 165, 170–71 (Neb. 2004); Beard v. Love, 173 P.3d 796, 804 (Okla. Civ. App. 2007); Summers v. Cherokee Children & Family Svcs., Inc., 112 S.W.3d 486, 528 (Tenn. Ct. App. 2002). 88 Corporate governance issues are often governed by the law of the state of incorporation. Because many companies incorporate in Delaware, the remainder of this section is devoted to a discussion of Delaware’s business judgment rule. § 141(e) of Delaware General Corporation Law protects directors of Delaware corporations who rely, in good faith, on an expert’s advice. Del. Code tit. 8, § 141(e) (“A member of the board of directors, or a member of any committee designated by the board of directors, shall, in the performance of such member’s duties, be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports or statements presented to the corporation by any of the corporation’s officers or employees, or committees of the board of directors, or by any other person as to matters the member reasonably believes are within such other person’s professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation”). 89 Brehm v. Eisner, 746 A.2d 244, 266 (Del. 2000).


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complaining party to show in the employment context. Your executive client may not receive everything he wants in an employment negotiation, but the board of a Delaware company essentially has the legal discretion under the business judgment rule to give him what he wants. The Delaware Supreme Court’s decision in Brehm v. Eisner shows how far a Delaware company board may go in its executive compensation decisions without running afoul of the business judgment rule.90 Brehm involved a separation agreement that The Walt Disney Company, a publicly traded corporation, entered into with its former president. The Walt Disney Company had fired its president without cause. The separation agreement’s cash severance payment exceeded $38 million, and the complaining shareholders alleged that the value of the accelerated vesting of the options in the separation agreement exceeded $100 million.91 The Delaware Supreme Court was disturbed by the compensation and severance package, which appeared “exceedingly lucrative, if not luxurious.”92 The Delaware Supreme Court was also concerned that the conduct of The Walt Disney Company’s board appeared, “casual, if not sloppy and perfunctory.”93 As to both the corporate waste test and to the board’s process, the Delaware Supreme Court concluded, “This is a close case.”94 The Delaware Supreme Court then ruled that The Walt Disney Company board’s conduct and severance package were protected by the business judgment rule: All good corporate governance practices include compliance with statutory law and case law establishing fiduciary duties. But, the law of corporate fiduciary duties and remedies for violation of those duties are distinct from the aspirational goals of ideal corporate governance practices. Aspirational ideals of good corporate governance practices for boards of directors that go beyond the minimal legal requirements of the corporate law are highly desirable . . . . But they are not required by the corporation law and do not define standards of liability.95 The Delaware Supreme Court dismissed the Brehm complaint without prejudice. Thereafter, the Disney shareholders filed an amended complaint in the Chancery Court. The amended complaint survived a motion to dismiss. Eventually, the Delaware Chancery Court held a 37-day trial on the merits and concluded that “the director

90

Id. Id. at 252–53. 92 Id. at 249. 93 Id. 94 Id. 95 Id. at 256. 91

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defendants did not breach their fiduciary duty or commit waste.”96 The Delaware Supreme Court affirmed the decision.97 In footnote 56 of its Brehm decision, the Delaware Supreme Court stated: To be sure, directors have the power, authority and wide discretion to make decisions on executive compensation . . . . [T]here is an outer limit to that discretion, at which point the decision of the directors on executive compensation is so disproportionally large as to be unconscionable and constitute waste.98 Given the magnitude of The Walt Disney Company’s severance package, it is difficult to ascertain the parameters of the outer limit.99 In the case of Citigroup and the separation package it gave to its departing CEO amidst the financial meltdown of 2007, $68 million might be the limit.100 In February 2009, the Delaware Chancery Court refused to dismiss a shareholder derivative action brought by disgruntled shareholders against Citigroup for allegedly providing a $68 million severance package, including bonus, salary, and accumulated stockholdings and other perks, to its departing CEO, an executive who the shareholders alleged had cost the company billions of dollars in losses.101 The business judgment rule does not protect officers and directors from illegal conduct.102 Consequently, when the SEC lays down executive compensation requirements, the requirements must be followed. And if the director or officer is involved in “fraud, bad faith, or self-dealing in the usual sense of personal profit or betterment on the part of the directors,” then the business judgment rule will not apply, and Delaware courts will pay greater attention to the director or officer’s actions.103 However, where there

96

In re The Walt Disney Company Derivative Litig., 907 A.2d 693, 697 (Del. Ch. 2005) aff ’d, 906 A.2d 27 (Del. 2006). 97 In re The Walt Disney Company Derivative Litig., 906 A.2d 27 (Del. 2006). 98 Brehm, 746 A.2d at 262 n.56 (internal citations omitted). See Gagliardi v. TriFoods Intern., Inc., 683 A.2d 1049, 1051 (Del. Ch. 1996) (dismissing allegation that executive compensation was excessive and constituted corporate waste); Saxe v. Brady, 184 A.2d 602, 610 (Del. Ch. 1962). 99 “[The waste test] is an extreme test, very rarely satisfied by a shareholder plaintiff, because if under the circumstances any reasonable person might conclude that the deal made sense, then the judicial inquiry ends.” Zupnick v. Goizueta, 698 A.2d 384, 387 (Del. Ch. 1997) (citations and internal quotations omitted). In Zupnick, the Delaware Chancery Court dismissed a claim brought against Coca-Cola Company and its board for waste arising from the board’s grant of an immediately exercisable stock option for 1,000,000 Coca-Cola shares to its CEO. The plaintiff alleged that the corporation received no consideration for the option because the option was granted for past services that the CEO “was already required to perform and for which he already had been amply compensated.” Id. at 386. 100 See In re Citigroup Shareholder Derivative Litig., 964 A.2d 106, 138–39 (Del. Ch. 2009). 101 Id. 102 Miller v. American Telephone & Telegraph Co., 507 F.2d 759, 762 (3rd Cir. 1974) (“different rules apply” when directors violate statutes and public policy). 103 In re The Walt Disney Company Derivative Litig., 907 A.2d 693, 747 (Del. Ch. 2005) (quotation omitted) aff ’d, 906 A.2d 27 (Del. 2006); see also In re Tyson Foods, Inc., 919 A.2d 563, 593 (Del. Ch. 2007) (“A director who intentionally uses inside knowledge not available to shareholders in order to enrich employees


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are no rules or regulations governing executive compensation, methods of executive compensation, or processes that lead to executive compensation, and the board acts in good faith, then the business judgment rule will probably protect the board in whatever executive compensation decision it makes.104

while avoiding shareholder-imposed requirements cannot . . . be said to be acting loyally and in good faith as a fiduciary”). 104 For a detailed analysis of the business judgment rule and potential director and officer liability, see Stephen A. Radin, The Business Judgment Rule: Fiduciary Duties of Corporate Directors (Aspen, 6th ed. 2009) (4 volumes); William E. Knepper & Dan A. Bailey, Liability of Corporate Officers and Directors (Mathew Bender, 8th ed. 2010) (2 volumes).

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Appendix Example of a Change in Control Agreement

The agreement below is a modified version of a publicly available change in control agreement that a public company’s board approved for its senior executive officers. The company presumably provides this agreement to all new executive hires on a take it or leave it basis. The agreement contains relatively pro-executive language, including some pro-executive language not discussed in this book. It also includes a Good Reason definition that does not adopt § 409A’s safe harbor language. ***** CHANGE IN CONTROL AGREEMENT105 This agreement (“Agreement”) is entered into by ______________ (“Executive”) and Your Employer, Inc. (“Company”). This Agreement shall be effective on the date Executive signs this Agreement. Recitals WHEREAS, the Company considers it essential to the best interests of its shareholders to foster the continuous employment of key management personnel. In this connection, the Board of Directors of the Company (“Board”) recognizes that the possibility of a change in control may exist and that such possibility, and the uncertainty and questions which it may raise among management, may result in the departure or distraction of management personnel to the detriment of the Company and its shareholders. WHEREAS, the Board has determined that appropriate steps should be taken to reinforce and encourage the continued attention and dedication of officers of the Company, including Executive, to their assigned duties without distraction in the face of the possibility of a change in control of the Company. WHEREAS, in order to induce Executive to join and/or remain in the employ of the Company and in consideration of Executive’s agreement set forth below, the Company agrees that Executive shall receive the benefits set forth in this Agreement under the circumstances described below. 1. Term of Agreement. This Agreement shall commence on the date Executive signs this Agreement and shall continue in effect for five years or until Executive’s employment with the Company is terminated, providing the employment termination occurs before a Change in Control.

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No copyright is claimed to this modified version of a publicly available document.


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2. Definitions. As used in this Agreement: (a) “Beneficial Owner” shall have the meaning ascribed to the term in Rule 13d-3 of the General Rules and Regulations under the Securities Exchange Act of 1934, as amended (“Exchange Act”). (b) “Business Combination” means and includes each and all of the following occurrences: (i) a consolidation or merger pursuant to which more than 50 percent of the Company’s Majority Voting Stock is transferred to different holders, except for a transaction intended primarily to change the state of the Company’s incorporation; or (ii) more than 50 percent of the assets of the Company are sold or otherwise disposed of. (c) “Change in Control” of the Company means and includes each and all of the following occurrences: (i) A Business Combination. (ii) When any “person” as defined in Section 3(a)(9) of the Exchange Act and as used in Sections 13(d) and 14(d) of the Exchange Act, including a “group” as defined in Section 13(d) of the Exchange Act but excluding the Company and any subsidiary and any employee benefit plan sponsored or maintained by the Company or any subsidiary (including any trustee of such plan acting as trustee), directly or indirectly, becomes the Beneficial Owner of securities of the Company representing 40 percent or more of the Majority Voting Stock; provided, however, that no crossing of such 40 percent threshold shall be a “Change in Control” if it is caused (x) solely as a result of an acquisition by the Company of its voting securities or (y) solely as a result of an acquisition of the Company’s voting securities directly from the Company. (iii) During any period of two (2) consecutive years, individuals who, at the beginning of such period, constitute the Board (“Incumbent Board”) cease for any reason to constitute at least a majority of the Board; providing, that any person becoming a director subsequent to the date hereof whose election, or nomination for election by the Company’s shareholders, was approved by the vote of at least a majority of the directors then comprising the Incumbent Board, shall be deemed a member of the Incumbent Board. (d) “Code” shall mean the Internal Revenue Code of 1986, as amended. (e) “Current Compensation” shall mean Executive’s monthly base salary, as in effect immediately prior to Executive’s termination of employment with the Company.

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Executive Employment Law (f) “Disability” shall mean a physical or mental illness or injury which, as determined by the Company, continuously prevents Executive from performing Executive’s duties with the Company for a period of six months prior to termination. (g) “Good Reason” shall mean grounds for termination by Executive of Executive’s employment by the Company as provided in § 5 of this Agreement. (h) “Majority Voting Stock” shall mean the class of the Company’s voting stock which, as of the time of determination, possesses the right to elect a majority of the directors of the Company. (i) “Separation from Service” shall mean a “separation from service” as defined in any regulations or other Internal Revenue Service guidance promulgated under § 409A of the Code. (j) “Termination Payment” shall mean the severance pay to which Executive is entitled upon termination of Executive’s employment within 24 months after a Change in Control as provided in § 3(a) hereof.

3. Compensation Following a Change in Control. (a) Subject to § 6 below, if Executive has a Separation from Service with the Company within 24 months after a Change in Control either as a result of (i) the involuntary termination of Executive’s employment by the Company other than a Termination for Cause or (ii) Executive’s voluntary termination of employment with the Company for Good Reason: (i) Executive shall be entitled to a Termination Payment, payable in cash, in an amount equal to 24 months of Executive’s Current Compensation at the rate in effect immediately prior to such Change in Control, subject to applicable withholding. (ii) in the event (x) that Executive’s ability to sell the stock of the Company is limited by the provisions of the Securities Act of 1933, as amended, or any rule or regulation promulgated there under, or (y) that Executive’s ability to sell the stock of the Company is limited by an agreement between Executive and the Company, Executive shall be entitled to exercise any stock option granted to Executive by the Company until the earlier of either (A) the date which is 30 days after the end of the period during which such limitation applies or (B) the end of the maximum term of the stock option. For purposes of clarity, this paragraph may only extend and shall not reduce the post-termination exercise period provided for in the respective option agreement. (b) Subject to § 6 below, upon the occurrence of a Change in Control: (i) (A) any stock option granted to Executive by the Company shall become fully vested and exercisable and shall remain exercisable in accordance with the


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terms of the applicable option award agreement, except to the extent modified by § 3(a), and (B) Executive shall have the right during the six month period following a Change in Control to have any such option “cashed out” at its market value determined as provided in this Agreement. The cash out proceeds shall be paid to Executive or, in the event of Executive’s death prior to payment, the representative of Executive’s estate. For this purpose, the market value of an outstanding option shall be measured as the difference between the option exercise price and the closing sales price of the common stock as reported by the NASDAQ National Market System (or, in the event the Company’s common stock is listed on a stock exchange, the highest closing price on such exchange as reported on the composite transactions reporting system) on the day prior to the date Executive elect to cash out the stock option. (ii) all forfeiture restrictions applicable to restricted stock granted to Executive by the Company shall lapse, and such restricted stock shall be released from the Company’s repurchase right set forth in the applicable restricted stock agreement. (c) Any cash payable to Executive under § 3(a)(i) shall be payable between 30 and 60 calendar days after Executive’s Separation from Service, provided, however, if, at the time of Executive’s Separation from Service, Executive is a “specified employee” (as defined in § 409A of the Code) and the payment under § 3(a)(i) is subject to § 409A of the Code, then the payment shall not be made until six months and one day following the date of Executive’s Separation from Service, except as may otherwise be permitted under § 409A of the Code. Any cash payable to Executive under § 3(b)(i) shall be made within 30 calendar days after the date the Company receives Executive’s written notice electing to be cashed out on the value of Executive’s options. With regard to cash payable to Executive, the payments shall each be classified as separate payments under Treasury Regulation § 1.409A-2(b)(2), and each separate payment shall be assessed for qualification as a short-term deferral under Treasury Regulation § 1.409A-1(a)(4), with the result that only the amount not classifiable as exempt from § 409A of the Code shall be regarded as subject to the distribution requirements of § 409A. (d) Anything contained in § 3(a) or § 3(b) above to the contrary notwithstanding, the Company shall have no obligation to pay Executive a Termination Payment, to accelerate the vesting of Executive’s options, to cash out Executive’s options, or to release Executive’s restricted shares from their forfeiture restrictions or repurchase rights under this Agreement in the event of Executive’s Separation from Service prior to a Change in Control. The Company shall also have no obligation to pay Executive a Termination Payment if, after a Change in Control, the Company terminates Executive’s employment for “Cause” or if Executive’s employment terminates due to Executive’s death, retirement, or resignation other than for “Good Reason.” 4. Termination for Cause. Termination of Executive’s employment with the Company shall be regarded as termination for “Cause” only upon: (a) Executive’s willful and continued failure to substantially perform Executive’s duties with the Company (other than a failure resulting from Executive’s incapacity

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Executive Employment Law due to physical or mental illness) after there is delivered to Executive by the Board a written demand for substantial performance which sets forth in detail the specific respects in which it believes Executive has not substantially performed Executive’s duties, and Executive is provided at least 15 days to cure the alleged lack of substantial performance; (b) Executive’s willfully engaging in gross misconduct which is materially and demonstrably injurious to the Company; (c) Executive’s committing a felony or an act of fraud against the Company or its affiliates; or (d) Executive’s breaching materially the terms of Executive’s employee confidentiality and proprietary information agreement with the Company.

No act, or failure to act, by Executive shall be considered “willful” if done, or omitted to be done, by Executive in good faith and in Executive’s reasonable belief that Executive’s act or omission was in the best interest of the Company and/or required by applicable law. Anything contained in this § 4 to the contrary notwithstanding, Executive shall not be deemed to have been terminated for Cause unless and until there shall have been delivered to Executive a copy of a resolution duly adopted by the affirmative vote of not less than a majority of the entire membership of the Board at a meeting of the Board called and held for that purpose (after reasonable notice to and an opportunity for Executive, together with Executive’s counsel, to be heard before the Board), finding that in the good faith opinion of the Board, Executive is guilty of conduct set forth in this Section 4 and specifying the particulars thereof in detail. 5. Termination for Good Reason. Executive’s employment with the Company, may be regarded as having been constructively terminated by the Company, and Executive shall become entitled to compensation pursuant to § 3 above if, upon notice to the Company within 90 days following the occurrence of one or more of the following events, with a 30-day opportunity for the Company to cure, Executive terminates Executive’s employment within two (2) years after a Change in Control by reason of one or more of the following events (unless the event(s) applies generally to all officers of the Company and any successor to the Company, or applies to a person solely in his capacity as a member of the Board): (a) without Executive’s express written consent, the assignment to Executive of any duties or the significant reduction of Executive’s duties, either of which is inconsistent with Executive’s position with the Company (or the duties and responsibilities of such position) immediately prior to a Change in Control, or Executive’s removal from or any failure to re-elect Executive to any such position; (b) without Executive’s express written consent, the substantial reduction, without good business reasons, of the facilities and perquisites (including office space and location) available to Executive immediately prior to a Change in Control;


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(c) a reduction by the Company in Executive’s salary or in any bonus compensation formula applicable to Executive as in effect immediately prior to a Change in Control, or the failure by the Company to increase the base salary each year following a Change in Control by an amount which equals at least one-half (1/2), on a percentage basis, of the average annual percentage increase in base salary for all officers of the Company (and any successor of the Company) during the prior two full calendar years; (d) a material reduction by the Company in the kind or level of employee benefits to which Executive was entitled prior to a Change in Control with the result that Executive’s overall benefits package is significantly reduced after the Change in Control; or the taking of any action by the Company which would materially and adversely affect Executive’s participation in any plan, program, or policy generally applicable to executives or employees of the Company or any successor of the Company, or deprive Executive in a material and substantial way of any fringe benefits enjoyed by Executive prior to a Change in Control; (e) the Company requiring Executive to be based at a location that is more than 30 miles from Executive’s principal location of employment on the date the Change in Control occurs, without Executive’s consent (except for required travel on the Company’s business to an extent substantially consistent with Executive’s present business travel obligations); (f) any purported termination of Executive’s employment by the Company which is not effected for Disability or for Cause, or any purported termination for which the grounds relied upon are not valid; or (g) the failure of the Company to obtain the assumption of this Agreement by any successor as contemplated in § 9 hereof. 6. Parachute Payments. In the event that any payment or benefit received or to be received by Executive in connection with a Change in Control, including any payments with respect to the termination of Executive’s employment with the Company or any corporation which is a related corporation (collectively, “Severance Payments”) would (i) constitute a “parachute payment” within the meaning of § 280G of the Code or any similar or successor provision and (ii) but for this § 6, be subject to the excise tax imposed by § 4999 of the Code or any similar or successor provision (“Excise Tax”), then the Severance Payments shall be paid to Executive either as: (a) the full amount of the Severance Payments, or (b) a lesser amount, which would result in no portion of the Severance Payments being subject to the Excise Tax (with reduction to occur in the following order: (x) reduction of payments of cash; and (y) reduction in equity awards; and with reduction in each category to be pro rata between those payments subject to § 409A and payments not subject to § 409A),

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whichever of the foregoing amounts, taking into account the applicable federal, state, and local income taxes and the Excise Tax, results in the receipt by Executive, on an after-tax basis, of the greatest amount, notwithstanding that all or some portion of the Severance Payments may be taxable under § 4999 of the Code. Unless the Company and Executive otherwise agree in writing, any determination required under this Section shall be made in writing by a mutually agreed independent public accounting firm or other independent third party (“Accountants”), whose determination shall be conclusive and binding upon Executive and the Company for all purposes. For purposes of making the calculations required by this Section, the Accountants may make reasonable assumptions and approximations concerning applicable taxes and may rely on reasonable, good faith interpretations concerning the application of § 280G and § 4999 of the Code. The Company and Executive shall furnish to the Accountants information and documents as the Accountants may reasonably request in order to make a determination under this Section. The Company shall bear all costs the Accountants may reasonably incur in connection with any calculations contemplated by this Section. 7. Disputes. If any dispute is finally determined in Executive’s favor, the Company shall pay all reasonable fees and expenses, including attorneys’ and consultants’ fees, that Executive incurs in good faith in connection with the determination. 8. No Mitigation. (a) Executive shall not be required to mitigate the amount of any payment provided for in § 3 of this Agreement by seeking other employment or otherwise, nor shall the amount of the payment be reduced by reason of compensation or other income Executive receive for services rendered after Executive’s termination of employment with the Company, providing that the amount of any payment provided for in § 3 may be offset by the Company by the amount of any indebtedness Executive may have to the Company at the time of Executive’s termination of employment. (b) In addition to the Termination Payment payable pursuant to § 3, Executive shall be entitled to receive all benefits payable to Executive under any benefit plan of the Company in which Executive participates. 9. Company’s Successors. The Company shall require any successor (whether direct or indirect, by purchase, merger, consolidation, or otherwise) to all or substantially all of the business and/or assets of the Company, to expressly assume and agree to perform the obligations under this Agreement in the same manner and to the same extent that the Company would be required to perform if no such succession had taken place. 10. Notice. Notices and all other communications required by this Agreement shall be in writing and shall be deemed given when (i) personally delivered, or (ii) five days


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after deposit in the United States mail, providing the mail is sent registered or certified, return receipt requested, and postage prepaid. Notices shall be sent to the addresses set forth in this Agreement, or to any other address as either party may send to the other under this Agreement. 11. Amendment or Waiver. No provisions of this Agreement may be modified, waived, or discharged unless the waiver, modification, or discharge is agreed to in writing by Executive and the Company. No waiver of either party at any time of the breach of, or lack of compliance with, any provisions of this Agreement shall be deemed a waiver of other provisions of this Agreement. 12. Sole Agreement. This Agreement represents the entire agreement between Executive and the Company with respect to the matters set forth in this Agreement and supersedes all other representations and agreements regarding the subject matter of this Agreement. 13. Executive’s Successors. This Agreement shall inure to the benefit of and be enforceable by Executive’s personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees, and legatees. If Executive should die while any amounts are still payable to Executive under this Agreement, all amounts, unless otherwise provided in this Agreement, shall be paid in accordance with the terms of this Agreement to Executive’s devisee, legatee, or other designee or, if there be no designees, to Executive’s estate. 14. Severability. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provisions of this Agreement, which shall remain in full force and effect. 15. Applicable Law. This Agreement shall be interpreted and enforced in accordance with the laws of the State of Delaware. 16. Withholding. The Company shall withhold legally required withholding taxes and other amounts required by law to be withheld on all payments made under this Agreement. 17. § 409A. (a) It is the parties’ intention that the benefits and rights to which Executive could become entitled to in connection with this Agreement, including any termination of employment, comply with § 409A of the Code or be exempt from § 409A of the Code. If Executive or the Company believes, at any time, that any benefit or right does not comply, the applicable party will promptly advise the other and both parties will negotiate reasonably and in good faith to amend the terms of this Agreement so that it complies with § 409A of the Code in the manner that has the most limited possible economic effect on Executive.

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Executive Employment Law (b) The Company will not take any action that would expose any payment or benefit to Executive to be accelerated or impose additional tax under § 409A of the Code, unless (i) the Company is obligated to take the action under an agreement, plan or arrangement to which Executive is a party; (ii) Executive requests the action; or (iii) the Company advises Executive in writing that the action may result in the imposition of accelerated or additional tax under § 409A of the Code and Executive subsequently requests in writing that the action be taken.

18. Counterparts. This Agreement may be executed by facsimile signature and in counterparts, each of which shall be deemed an original, but all of which together will constitute one instrument. WHEREFORE, the parties voluntarily enter into this Agreement by signing below.

Excerpts from a Holdback Retention Agreement

Following are excerpts from a modified holdback retention agreement heavily negotiated during an M&A transaction between the acquirer and the target’s management team. This is not a form, nor even a form-like agreement. Key sections from the agreement have been omitted, including sections addressing taxation and indemnification issues and miscellaneous matters. During the negotiations, each party retained tax counsel and 280G experts, in addition to their regular attorneys. The purpose of including these excerpts is to demonstrate that the topics discussed in this book will help you draft your most complicated executive and entrepreneur agreements. In the holdback retention agreement below, the founder deposits millions of dollars from the sale of his stock into an escrow account, and subjects the funds to possible forfeiture to the acquirer. The executive’s right to receive the funds from the escrow is time-based. Funds are released over a three-year period, providing the executive continues to work for the acquirer, and the executive’s employment is not terminated for Cause by the acquirer, or by the executive without Good Reason. If the acquirer terminates the founder’s employment without Cause, or the founder resigns for Good Reason, then the escrowed funds are delivered to the founder. The founder’s assurance that he will eventually receive the millions in held back funds, and the founder’s protection against forfeiture of the funds, comes down to the definitions of “Cause” and “Good Reason” in the agreement. The “Cause” and “Good Reason” definitions used in the agreement have been removed because they are for you to negotiate (after you read the sections in this book that discuss “Cause” and “Good Reason”). *****


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HOLDBACK RETENTION AGREEMENT106 This Holdback Retention Agreement (“Agreement”) is made as of February 1, 2011 between John J. Founder (“Founder”) and Acquirer corporation (“Company”). Concurrent with the execution and delivery of this Agreement, multiple parties, including the Company, are entering into an Agreement and Plan of Merger (“Merger Agreement”). Capitalized terms used but not defined in this Agreement shall have the meanings given to them in the Merger Agreement. Pursuant to, and subject to the terms and conditions set forth in, the Merger Agreement, all of the shares of Outstanding Capital Stock and Outstanding Vested Options held by the Founder will be converted into the right to receive the cash consideration set forth in the Merger Agreement. For purposes of this Agreement, the aggregate amount of such cash consideration, including the aggregate amounts to be contributed to the Escrow Funds by the Founder, shall be referred to as the Founder’s “Aggregate Consideration.” The Founder has agreed that a portion of the Aggregate Consideration to be paid to him in the Merger shall be deposited into an escrow account. In certain circumstances, all or part, as applicable, of the amount deposited in such escrow account may be subject to relinquishment to the Company, provided that relinquishment to the Company may only occur under the specific circumstances set forth in this Agreement. The parties, intending to be legally bound, for good consideration, the sufficiency of which is hereby acknowledged, agree as follows: 1. Escrow of Relinquishment Amount. Promptly following the Effective Time, the Founder agrees that the Company shall deposit 45 percent of the Founder’s Aggregate Consideration (“Relinquishment Amount”) into an escrow account (“Escrow Account”) to be held by Bank (“Founder’s Escrow Agent”) in accordance with the terms of this Agreement and the Founder’s Escrow Agreement. The Founder’s Escrow Agreement is attached hereto as Exhibit A. The parties acknowledge and agree that the Relinquishment Amount shall be comprised entirely of consideration for the Founder’s Outstanding Capital Stock (with the Founder having discretion to designate which shares of Outstanding Capital Stock the consideration for which shall be so deposited to satisfy the requirements of this Section 1), and no part of the Relinquishment Amount shall be comprised of consideration for the Founder’s Outstanding Vested Options.

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No copyright is claimed to this document.

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2. Section 83(b) Election. The Founder shall make a valid and timely election under Section 83(b) of the Internal Revenue Code of 1986 (“Code”) with respect to the escrow of the Relinquishment Amount (“83(b) Election”). The Founder shall make such election directly to the IRS within 30 days after the Closing Date. 3. Relinquishment. (a) If, during the period commencing on the Closing Date and ending on the third anniversary of the Closing Date, a Relinquishment Event (as defined below) occurs, then the amount held in the Escrow Account as of the date of occurrence of the Relinquishment Event (other than any amount that is no longer subject to relinquishment pursuant to this Agreement) shall immediately be relinquished to the Company and the parties shall, within 10 days following the occurrence of such Relinquishment Event, deliver joint written instructions to the Founder’s Escrow Agent instructing that such amount be released from the Escrow Account and delivered to Company. (b) If, during the period commencing on the Closing Date and ending on the third anniversary of the Closing Date, a Suspension Event (as defined below) occurs, then . . . the amount held in the Escrow Account as of the date of occurrence of the termination of employment (other than any amount that is no longer subject to relinquishment pursuant to this Agreement) shall remain in the Escrow Account (and continue to earn interest) until the end of the Suspension Period (as defined below) for such Suspension Event and the full amount then remaining in the Escrow Account shall be delivered in full to the Founder or relinquished to Company as set forth more fully below. (c) If, during the period commencing on the Closing Date and ending on the day before the first anniversary of the Closing Date, a Relinquishment Event occurs, then all rights of the Founder to receive any unpaid cash disbursements from the Indemnity Escrow Fund pursuant to the terms of the Merger Agreement or otherwise shall, without any action required on the part of the Founder or any other Person, immediately be relinquished to the Company and the Company shall be entitled to instruct the Escrow Agent (as defined in the Merger Agreement) (“Indemnity Escrow Agent”) to pay such disbursements to the Company in lieu of to the Founder. (d) If, during the period commencing on the Closing Date and ending on the day before the first anniversary of the Closing Date, a Suspension Event occurs, then all rights of the Founder to receive any unpaid cash disbursements from the Indemnity Escrow Fund pursuant to the terms of the Merger Agreement or otherwise shall be suspended until the end of the Suspension Period for such Suspension Event, and Company shall be entitled to instruct the Indemnity Escrow Agent to retain such disbursements in a separate escrow account (“Founder’s Account”) until such time as the Company delivers written instructions to the Indemnity Escrow Agent providing for the disbursement of the amounts held in the Founder’s Account in the manner set forth below. At the end of the applicable Suspension Period, the


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amounts held in the Founder’s Account shall be delivered in full to the Founder in the event the suspended amounts from the Escrow Account are delivered to the Founder, or relinquished to the Company in the event the amounts held in the Escrow Account are relinquished to the Company as set forth more fully below. The Company shall be required to deliver written instructions to the Indemnity Escrow Agent providing for the disbursement of amounts held in the Founder’s Account in accordance with the provisions of this Agreement. For purposes of this Agreement: (i) a “Relinquishment Event” shall occur only: (x) if the Founder voluntarily resigns his employment with the Company, or any Affiliate of the Company other than for Good Reason; or (y) if the Founder’s employment with the Company or any Affiliate of the Company is terminated for Cause. Notwithstanding any other term in this Agreement, a resignation by the Founder at the request of the Company or any Affiliate of the Company (other than a resignation by the Founder as a corporate officer or director of the Company effective as of the Effective Time) shall be deemed a termination without Cause for purposes of this Agreement. (ii) “Good Reason” means only, without the Founder’s written consent . . . . (iii) “Cause” means only . . . . (iv) “Suspension Event” shall mean the termination of the Founder’s employment with the Company or any Affiliate of the Company for any of the following reasons: (x) the Founder is indicted for any felony, any crime of moral turpitude punishable by incarceration of six months or more, insider trading in violation of the federal securities laws or a violation of the Foreign Corrupt Practices Act (“Indictment”); (y) a government agency brings a civil action against the Founder for insider trading in violation of the federal securities laws or for a violation of the Foreign Corrupt Practices Act (“Civil Action”); or (z) the Company determines, after a reasonable and good faith independent outside investigation, that the Founder has breached the Founder’s fiduciary duty to the Company or has committed illegal harassment, illegal discrimination, insider trading in violation of the federal securities laws, or a violation of the FCPA (“Internal Determination”). (v) The “Suspension Period” shall mean . . . 4. Release of Escrow for Permitted Termination Event. In the event the Founder’s employment with the Company or any Affiliate of the Company is terminated at any time before, on or following the Closing Date for any reason (including, without limitation, for death or disability of the Founder), other than a termination of employment that constitutes a Relinquishment Event or a Suspension Event, then the parties shall, within 10 days of the final day of Founder’s employment (or, if the termination of Founder’s employment occurs before the Closing Date, then 10 days after the Closing Date), deliver joint written instructions to the Founder’s Escrow Agent to release from the Escrow Account and deliver to the Founder an amount

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equal to: (a) the entire amount then held in the Escrow Account (including interest); minus (b) the aggregate amount of all unpaid fees and unpaid expenses of the Founder’s Escrow Agent incurred on or prior to the date of such release that have not yet been satisfied out of the Escrow Account or out of amounts that have otherwise been released to the Founder from the Escrow Account or otherwise. 5. Annual Release of Escrow. In addition to the provisions set forth above in this Agreement: (a) In the event the Founder is employed by the Company or any Affiliate of Company on the first anniversary of the Closing Date, the Founder’s Escrow Agent shall, on the date that is five business days after the first anniversary of the Closing Date, release from the Escrow Account and deliver to the Founder an amount (“First Annual Release Amount”) equal to: (i) 22.22 percent of the Relinquishment Amount; plus (ii) all interest earned on such amount since the date the Relinquishment Amount was deposited into the Escrow Account with the Founder’s Escrow Agent; minus (iii) the aggregate amount of all fees and expenses of the Founder’s Escrow Agent incurred on or prior to the date of such release that have not yet been satisfied out of the Escrow Account or otherwise; minus (4) the sum of all Indemnification Amounts (as defined below), if any, released from the Escrow Account on or prior to the first anniversary of the Closing Date; provided, however, that if the Tax Amount (as defined below) is released from the Escrow Account in accordance with Section 6 prior to the first anniversary of the Closing Date, then the amount to be released from the Escrow Account to the Founder Parties in accordance with this Section 5(a) shall be the amount by which the First Annual Release Amount exceeds 22.22 percent of the Tax Amount, if any. Notwithstanding any other term in this Agreement, once the First Annual Release Amount is released from the Escrow Account to the Founder in accordance with this Section 5(a), the First Annual Release Amount shall no longer be subject to relinquishment under this Agreement. (b) In the event the Founder is employed by the Company or any Affiliate of Company on the second anniversary of the Closing Date, the Founder’s Escrow Agent shall, on the date that is five business days after the second anniversary of the Closing Date, release from the Escrow Account and deliver to the Founder Parties an amount (“Second Annual Release Amount”) equal to . . . . (c) In the event the Founder is employed by the Company or any Affiliate of Company on the third anniversary of the Closing Date, the Founder’s Escrow Agent shall, on the date that is five business days after the third anniversary of the Closing Date, release from the Escrow Account and deliver to the Founder Parties an amount (“Final Release Amount”) equal to . . . . WHEREFORE, the parties voluntarily entered into this Agreement by signing below.

9 T E R M I N AT I O N O F THE E M PLOYM E N T RE L ATI O N S HI P

§ 9.1 Leaving the Employer

§ .. the executive is fired Even CEOs get fired! So do presidents, chief operating officers, chief technology officers, executive vice presidents, chief marking officers, general managers, and vice presidents of engineering. They get fired all the time, for all sorts of reasons.1 Even public company chief financial officers, fresh from reporting issues to their employers’ audit committees, get fired. Not often. But it does happen. If you practice long enough, you will undoubtedly receive calls from company counsel asking you to take care of their executives and informing you, without violating their

1

According to a ten-year study of CEO successions at the world’s 2,500 largest companies, yearly CEO turnover rates across all industries from 2000 to 2009 ranged from 12 percent to 14 percent, except in the telecommunications industry, where the turnover rate averaged 16.8 percent per year (the turnover rate includes both forced successions and planned successions). Ken Favaro, Per-Ola Karlsson & Gary L. Neilson, CEO Succession 2000–2009: A Decade of Convergence and Compression, Strategy+Bus., Summer 2010, at 4, available at http://www.strategy-business.com/media/file/sb59_10208.pdf. In 2009, 12.4 percent of North American CEOs were replaced. Id. The study concludes, “The tenure of CEO is becoming shorter and more intense, the margin for error or underperformance is narrow, and the role of CEO increasingly excludes the job of also being chairman.” Id. at 2. In the second year of the study, the authors analyzing the data determined: “The conclusion is inescapable: Forced CEO succession has become the ‘new normal.’” Chuck Lucier, Rob Schuyt & Eric Spiegel, CEO Succession 2002: Deliver or Depart, Strategy+Bus., Summer 2003, at 1, available at http://www.beresfordresearch.com/pdfdocuments/ ceo_succession_2002.pdf.

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professional obligations, that their leaders are doing a great job . . . but . . . a board member believes he can run the company better . . . a powerful investor is irate about an insignificant product delay . . . a new venture capitalist insists his “gray-haired” man is the right guy to run the company . . . . In at-will employment relationships, employers may fire their executive employees at any time, with or without notice, and with or without cause. There is no law that makes it illegal to fire an executive who is doing a great job. Firing the performing executive may be foolish as a business matter. It may even be that if the shareholders could vote, they would vote against the termination. However, it is not illegal to mismanage a business. It is not illegal to run a company into the ground. It is not illegal to file for bankruptcy protection or to liquidate. While more than a few employment terminations are economically irrational, others are richly deserved. Some executives have little idea how to run a company. Others are run-of-the-mill managers who happen, for one reason or another, to have risen to the top. Sometimes, executives are simply in the wrong place at the wrong time. Events such as shifts in business strategy, mergers, or changes at the top may lead to involuntary executive exits, even for managers who are performing. In a 2009 report, two corporate transformation consultants recommended that within 60 days of taking the job, new CEOs fire subordinates who they do not want on their management teams, even if no successors have been identified.2 There are also those executives who shine as managers of certain types of companies but are incapable of running other classes of businesses. The CEO who excels at bringing start-ups from $0 to $50 million in annual revenue might not be the best person to manage a $250 million a year company and might fail spectacularly if asked to run a $5 billion a year public company. By contrast, the CEO of a Fortune 100 company might be out of his league in a $2 million-a-quarter start-up. The executive who knows chip companies may not know the first thing about managing an insurance, software, or biotech company. More often than not, the employer terminates the executive’s employment in a professional manner. The “it is time to go” conversation may begin: “Things aren’t working out. I know it’s tough, but we are going to have to replace you. We want to treat you professionally, so let’s work out a severance arrangement that is good for everybody.” Unfortunately, numerous employers deliver the employment termination message in more hurtful, incompetent ways. Dysfunctional people run some companies, and they may terminate subordinates’ employment in dysfunctional ways. For example, the true conflict avoider may attempt to shed subordinates without actually firing

2

Per-Ola Karlsson & Gary L. Neilson, CEO Succession 2008: Stability in the Storm, Strategy+Bus., Summer 2009, at 10, available at www.booz.com/media/uploads/CEO_Succession_2008.pdf.

Termination of the Employment Relationship

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them. In unusual circumstances, employer dysfunction will lead the executive to file a claim against his employer while he is employed.3 Founders are a special subset of executive, especially when it comes to being fired from the companies they birthed. On the one hand, founders are regularly victims of ugly and painful firings. They are sometimes mistreated, forced out of their companies for no reason other than they lost control of the board. More than one venture capitalist has planned to terminate a founder as soon as the capital financing closed to “steal back” the founder’s unvested equity and redistribute it to the investors. Moreover, newly hired CEOs frequently purge founders who have stepped aside, simply to remove all potential threats and stamp the company in the new CEO’s image. On the other hand, many a founder has hurt the company he built by staying on too long, in the way an aging athletic star sometimes plays one season too many. The founder who has given birth to a company, who worked without pay for months or years, who toiled on despite lights flickering low, who visited a hundred investors before one said, “yes,” whose baby is the company: these founders often have a very difficult time letting go. And when their employment is terminated, emotions may run high. When you receive the “I’ve just been fired” phone call, you must listen not only to the facts and circumstances but also possibly to the consternation and hurt. No one, no matter how experienced or self-confident, enjoys being fired. Once you have some experience representing executives, you will be able to offer advice along the following lines: I know you are really upset that you were just laid off and this might not make you feel any better, but the fact of the matter is that very successful people just like you get fired all the time, often for very bad or economically irrational reasons. Our country is full of CEOs and multimillionaires who got fired two, three, and four times before they made it. You may not feel very good right now, and I know you’re angry at what happened, but let me tell you: Many of my executive clients call me six months after they lose their jobs and tell me the best thing that ever happened to them was that they got fired. The departing executive or entrepreneur who has not negotiated severance protection as part of his employment agreement is left with a back-end severance negotiation. This chapter discusses various dynamics of severance negotiations and typical severance agreement clauses.

3

If the executive files a claim against his employer while employed, and the employer thereafter terminates the executive’s employment without exchanging severance pay for a release, the employer may be inviting a wrongful termination and/or retaliation claim.

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§ .. the squeeze out — asking for a separation agreement Employers do not always fire their executives. Many times, they force them out by “signaling” to their executives that they are no longer wanted. Signaling may be subtle, or it may be in your face. Employers signal, rather than fire, for many reasons: corporate style; inertia; misfeasance; malfeasance; and as noted above, dysfunctionality. There are innumerable ways a superior (or company) may signal an executive that he is no longer wanted. A reorganization, leaving the executive missing from the organizational chart (or in a severely diminished role), is one classic method. Repeatedly and pointedly ignoring the executive’s input is another. People often see and hear what they want to see and hear. Executives and entrepreneurs are no different. Frequently, they do not receive the it’s-time-to-go message. Many executive or entrepreneur clients will ask you what they should do to return to the fold, sometimes insisting they (or HR) can fix the problem, when it is painfully obvious to you that the employer (or the executive’s boss) no longer wants the executive in its employ. In these situations, you might ask the client: “So, why do you want to work there?” or “Why do you want to work at a place that doesn’t want you?” Other times, you might simply say, “The company [your boss] is telling you it [he] doesn’t want you anymore.” If your executive client is amenable, it may behoove him to open the severance negotiation. After some counseling by you, many executives and entrepreneurs will decide to ask their superiors for severance, rather than suffer through repeated additional signaling. Many times, when the squeezed out executive acknowledges that he understands his manager no longer wants him, and contemporaneously requests a severance package, the manager will be visibly relieved and work to produce an acceptable severance package. Even when the superior shows no emotion, he will often provide a commercially reasonable separation agreement. There is risk to a subordinate executive opening the severance negotiation. The employer may say, “no.” Or worse, the employer may play hardball, refuse to offer severance—and erroneously but deliberately—claim the executive resigned. For this reason, all executives should make absolutely clear when requesting a severance package that they are not resigning. Following is a genre of conversation that an executive might use in an appropriate situation: [Name of Manager], I can see from everything that is going on recently that the company doesn’t want me around anymore. I’m not resigning because I’m happy to continue doing everything I’m doing and I’ll continue to do it well. But, if the company doesn’t want me anymore, that’s all right, as long as the company offers me a reasonable severance package. Your executive and entrepreneur clients will be pleasantly surprised how often a well-handled request for a severance agreement leads to positive results.


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§ .. the ultimate squeeze out — the performance improvement plan Performance Improvement Plans (PIPs) are often, although not always, the death knell for the employee.4 Many mature employers (who have had to defend multiple employee lawsuits over the years) use PIPs to protect the employer in the event the fired employee sues the company, not to assist the employee in improving performance. A well-written employer-protective PIP will include so many “performance goals” that even a superstar employee would fail the test. When the targeted employee “fails” to meet the performance objectives, the employer fires the employee and thereafter claims that the employee was a bad apple.5 It is true that some employers genuinely hope to improve performance when they place an employee on a PIP. Managers at these employers may work closely with employees, providing coaching where necessary. Sometimes, employees successfully “improve” their performance under a PIP, thereby saving their jobs. However, when an executive walks into your office with PIP in hand, you should, in no uncertain terms, tell him to immediately start looking for alternative employment. Doing so will reduce his downside risk. If, during the meeting where the employer presents the PIP to your executive client, the employer also offers the executive the opportunity to choose a severance agreement, then the employer is almost always bluntly signaling (telling) the executive that it is time to go. The executive should strongly consider negotiating his separation package. If the executive chooses the PIP, he should secure alternative employment as soon as possible and before the time period for the PIP expires because the employer may terminate the executive’s employment after the PIP without offering an equally generous (or any) severance package. Even where the PIP is not accompanied by a severance agreement, the executive should strongly consider opening the severance negotiation. The odds are that the executive will not survive the PIP.

§ 9.2 Why Employers Offer Separation Agreements

Some of the reasons employers offer separation agreements to departing executives when they are not required to do so are discussed below.

4 5

Performance Improvement Plans are discussed in § 4.16. If the employee is fired after failing a PIP and sues, the employer may argue to the jury or court something similar to the following: We have no obligation to retain underperforming employees. We did everything possible to help this employee succeed. We even gave the employee a report with detailed goals and ninety days of coaching to help the employee succeed. And the employee failed. In an increasingly competitive economy, we need the best employees to succeed as a company, and this employee was not one of those.

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§ .. separation agreements offered to secure releases Employers offer severance agreements to buy a general release of claims. The severance compensation is the cost of obtaining the release. Employment claims can be real, and they can be imagined. They can be known or unknown at the time of termination. In some instances, employers believe there are potential claims that may be brought against them.6 In other instances, employers feel just the opposite. Employment lawsuits can be expensive to defend. Employers understand that the cost of defending a lawsuit, no matter how weak the lawsuit, may far exceed the cost of severance. The general release covering all known and unknown claims buys the employer peace. § .. separation agreements for repeat players An employer may expect that it will see the departing executive down the proverbial “business road” and thus may wish to cushion the executive’s departure. An employer never knows when the COO it just fired will turn up as CEO of a customer, joint venturer, or other entity. The employer reasons that it is better to treat the departing executive with respect than to cause needless antipathy, with the potential of a later business backlash. The repeat player concern is not theoretical. Sometimes, board members of a departing executive’s ex-employer (who have just consented to the firing of the executive) will contact the newly fired executive about other business opportunities. The private equity investor may call the executive the day after the firing to ask him to look at one of his other portfolio companies. Similarly, the board member of a public company may call a just-fired executive to interview for the open position at a company that may be a “better fit.” § .. separation agreements intended to reflect corporate culture Employers also offer severance packages as an extension of the corporate culture they create. Employers seeking “happy” or “content” workforces may use an assurance of severance to reinforce to their employees that the employer will always be there for them, even on the way out. The message: “No one likes employment terminations, but if you are terminated, we will take care of you on departure.”

6

Some employers have an unwritten policy of age discrimination and “buy” the right to discriminate (or commit other civil wrongdoing) with lucrative severance agreements that an executive would be foolish to turn down.


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§ .. separation agreements offered because the executive is an executive Executive culture is a subcategory of general corporate culture. Directors and officers offer severance to their colleagues, in part, because they, too, expect a severance package when it is time to go (“there but for the grace of God, go I”); in part to keep other management team members content (“if he fires me just like he fired Rick, at least I’ll get a decent package”); in part to act as they perceive professionals of the executive class should (“the right thing to do when you fire a senior executive is give him a severance package”); in part to assuage guilty feelings (“I’m really mistreating him, so I’ll give him a severance package”); and undoubtedly, in part, for other reasons.7

§ 9.3 ERISA Severance Plans

Mature employers may have an ERISA plan, which provides severance based on a formula to all qualifying employees whose employment is terminated (typically employment must be terminated without Cause). ERISA severance plans are an ideal way for employers to show they “care” and to provide an important benefit to employees.8 When it adopts an ERISA severance plan, the employer obligates itself to provide severance to all qualifying employees according to the formula set out in the plan. Invariably, the plan will require that the employee sign a release as a condition for receiving the severance payment. Having an ERISA plan streamlines separations and provides a bulwark against employees who would like to negotiate “one off ” back-end severance agreements. The ERISA plan’s formula and release are formulaic, and HR will say as much to the employee requesting special dispensation. ERISA plans may also protect the employer if disputes arise because “abuse of discretion” is the standard of review for an ERISA plan administrator with discretionary

7

In a 2008–2009 survey of human resource executives, performed by a third-party research firm for HR consultants Lee Hecht Harrison (LHH) using LHH’s database, the top six reasons human resource executives gave for the existence of their companies’ severance policies were (1) “Avoiding future litigation,” (2) “[Being the] employer of choice,” (3) “View former employees as future customers,” (4) “Government regulatory/compliance,” (5) “Treat fairly/respectfully,” and (6) “Right thing to do.” Severance & Separation Practices: Benchmark Study 2008–2009 (2009), Lee Hecht Harrison, at 1, 20, available at http://www.lhh. com/knowledgecenter/Pages/Severanceseparationpractices.aspx (free registration required). In a study of 179 CEOs of Fortune 500 companies who left their employers between 1996 and 2002, David Yermack of New York University’s Stern School of Business concluded, “Several results appear to support an ad hoc interpretation that boards use severance pay to assure CEOs of a minimum lifetime wage level . . . . [P] atterns suggest that certain norms of equity or fairness influence firms’ decisions about how to compensate exiting CEOs, without clear attention to any theory of economic optimization.” David Yermack, Golden Handshakes: Separation Pay for Retired and Dismissed CEOs, 41 J. Acct. & Econ. 237, 255 (2006). 8 See § 9.2.3.

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authority to administer the plan.9 The strict standard makes appealing a severance plan administrator’s adverse decision more difficult than otherwise might be the case.

§ 9.4 Negotiating the Separation Agreement

§ .. the executive’s chronology When the executive calls to tell you he has been fired, he will invariably want help yesterday. As explained in § 5.1.2, § 5.1.3, and § 9.1.1, you will almost surely be required to listen to the entire story on the phone—and perhaps in person. It is impossible to give your executive client the best advice unless you learn everything there is to know about his professional life, especially why he believes he was fired, what he believes his leverage is, what his goals are for the severance negotiation, and who the players are. The executive’s chronology of events will go a long way to explaining these and other facts that may affect his severance negotiation.10 The chronology of events may also allow you, with your trained eye, to determine whether, and to what extent, the executive has legal claims against the employer. § .. the loose market for severance Few employers refuse to provide severance to executives they terminate without cause. Even though the executive is an at-will employee, and the employer has no obligation to provide severance, there is a “loose market rate” for executive severance, a range that both sides will recognize as commercially reasonable. The “loose market rate” is a “loose range” that may fluctuate by geographic area, industry, seniority, employer, investor influence, and executive personality. Knowing the “loose range” is important, however, for at least two distinct reasons. First, your client’s severance expectations may require recalibration. Many executives initially insist they will not settle for anything less than multiple years of severance and full acceleration of the vesting of their equity. If the “loose market rate” is six months’ severance and one-year vesting acceleration, the executive will probably not receive anything close to his initial severance demand. Second, the ex-employer may need to be told its initial severance offer is commercially unreasonable. The challenge will only work, of course, if you understand the market.

9

Metropolitan Life Ins. Co v. Glenn, 554 U.S. 105 (2008). Glenn inexplicably holds that the standard of review remains fixed even where a clear conflict of interest exists (for example, where the plan administrator is the employer) but requires a reviewing court to consider the conflict during its review. In Glenn, the Supreme Court affirmed a lower court’s reversal of a plan administrator’s decision because of a conflict of interest. Id. at 119. 10 See § 5.3.1 for a more complete discussion of an executive’s chronology of events.


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There are a number of ways to determine the parameters of commercially reasonable executive severance. These include: • Obtaining data from compensation experts; • Determining the employer’s severance offers to executives who have previously left the employer; • Examining publicly disclosed severance agreements (for public companies); • Asking your client to poll his friends who have recently received severance packages; • Speaking with local practitioners; and • Your experience.

§ .. the departing executive’s leverage To the extent that one or more of the motivations discussed earlier in this chapter drive an employer to offer severance, the executive has leverage. A manager’s desire “to do the right thing,” for example, may give the departing executive power to lay out and negotiate a “fair” severance or the “right” severance, given the particular circumstances of the departure. In addition to leverage gained from the employer’s motivations, there are at least eight principal components of executive-driven leverage, four arising from potential legal claims and four arising from business concerns. They are: 1. The quality of the executive’s legal claims, if any, against the employer; 2. What, if anything, the executive will do about his legal claims; 3. The employer’s assessment of the quality of the executive’s legal claims against it; 4. The employer’s belief about what the executive will do with his legal claims; 5. The executive’s post-employment ability, if any, to affect the employer’s business; 6. What, if anything, the executive will do post-employment about his ability to affect the employer’s business; 7. The employer’s assessment of the executive’s post-employment ability to affect its business; and 8. The employer’s belief about what the executive will do in the future with his ability to affect its business. § 9.4.3.1 Does the Executive Have Legal Claims Against the Employer? If the executive has been legally wronged by his employer, then he may be in a position to aggressively pursue his goals during a severance negotiation. For example, if the executive has been fired after complaining about a manager’s unwanted groping or after filing a complaint against the employer, the executive’s negotiating leverage may

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be increased. This is especially true if other employees confirm the executive’s version of the facts. Consequently, to be able to best advise your executive client, you must be familiar with federal and state employment, contract, securities, and intellectual property laws that may affect executives. While employment and contract law issues arise most frequently in executive employment relationships, securities law and intellectual property law issues may also affect the relationship.11 Section 8.2.6 describes various laws affecting executives during their employment. If the employer has violated one or more of these laws vis-à-vis the executive, then the executive may have a claim against his employer. § 9.4.3.2 The Difference Between Bad Management and Illegal Conduct Only terminations undertaken for an illegal reason give rise to legal liability. It is not illegal to fire an executive for a bad reason, for a foolish reason, nor for a contrived reason, as long as the reason for the termination is not an illegal one. Furthermore, it is not illegal to mismanage a company. The executive will often not know the difference between a legally wrongful termination of employment and a legally acceptable (albeit, perhaps foolish) termination of employment. Hence, you will be required to educate your client by explaining that legal leverage is far less in the case of a legally acceptable employment termination than in the case of a wrongful one. § 9.4.3.3 What, if Anything, Will the Executive Do About His Legal Claims? The executive’s ability to force results during severance negotiations depends in large part on how far the executive is willing to press his claims. On balance, the executive willing to file a court case or arbitration demand is more likely to force results during back-end severance negotiations than the executive unwilling to cause a conflict.

11

Employees who “work” for a company before the company is formed or before becoming an employee and who do not sign intellectual property assignment clauses/agreements may, under certain circumstances, have significant intellectual property claims against their employers. For example, a software engineer who writes the code for his employer’s software product in pre-incorporation days and who does not sign an intellectual property assignment agreement may be a joint owner of the software. See 17 U.S.C. §§ 101, 106, 201; Aymes v. Bonelli, 980 F.2d 857 (2d Cir. 1992) (even though programmer developed program at behest of company, on company time and company equipment, because company treated programmer as independent contractor, program was not work for hire and belonged to programmer); Massingill v. Stream, Ltd., No. 3:08-cv-0091-M, 2009 WL 3163549 (N.D. Tex. Oct. 1, 2009) (code written while independent contractor and before full-time employment is not work for hire and belongs to programmer); but see JustMed, Inc. v. Byce, 600 F.3d 1118 (9th Cir. 2010) (despite lack of formal employment and very informal working conditions, employment relationship existed and software belonged to company as work for hire).


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§ 9.4.3.4 Perceptions Matter Even more important than whether the executive has legal claims and, if so, what the executive will do with them, is the employer’s perception about the quality of the executive’s legal claims and its perception about what the executive is likely to do about his claims. Perceptions often matter more than reality in negotiations. If an employer believes the employee is likely to file a legal case against it, even though it believes the claim to be a weak one, all other things being equal, the employer will be more likely to buy off the executive with a larger severance offer. If the employer believes the executive is off his rocker, ready to go to war over his severance, and the employer wishes to avoid litigation, the executive may be able to negotiate a healthy severance package.12 By contrast, if the employer believes there is no chance the executive will file a legal claim against it, no matter how powerful the executive’s claims, the employer will be less likely than otherwise to move during severance negotiations. § 9.4.3.5 The Executive’s Preexisting History An employer’s perception of what its ex-executive will and will not do may be set by the company’s prior experiences with the departing executive. The executive who has backed down from management conflict for years and been a subservient “yes man” throughout his career is unlikely to convince his employer that he will be a tiger on exit. Even the most experienced negotiator will have a difficult, if not impossible, time overcoming employer perceptions of the departing executive ingrained over many years. Consequently, if your executive client begs you to negotiate for him, and he happens to have led a meek and subservient professional life, feel free to bluntly tell him that his employer’s perceptions about the choices he is likely to make may be impossible to overcome, regardless of whether you or he negotiates on his behalf.13 § 9.4.3.6 The Executive’s Business Leverage The analysis of back-end negotiating leverage devolving from the executive’s business leverage is similar to the analysis of his legal claim–driven leverage. The discussion in the prior sections is applicable, although in the analysis, business pressure points should be substituted for legal claims and the employer’s business-related perception for its legal-related perception.

12

Perceptions can be determinative. But not always. Some employers, seemingly as a matter of corporate policy, may require former employees to file claims against them before they will seriously negotiate a severance package significantly higher than the initial package offered. 13 This is especially true if the employee has, at any point, signaled he will accept whatever severance he is able to negotiate without conflict.

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Executive Story Juan worked as a vice president in the engineering department of a large Midwestern employer. Juan’s new boss terminated him at 4:00 p.m. one Friday. Juan was stunned. He believed he was doing a stellar job. Juan’s new boss did not handle the employment termination very well. When Juan asked about severance benefits, Juan’s boss told him he wasn’t entitled to anything. Juan did not handle his employment termination all that well either. On his way out, he “left” a pair of dirty cleats on his desk. The company’s logo “happened” to be under the cleats. Juan told me his manager was recently promoted from another division in the company and did not know the first thing about the technology in which Juan specialized. Juan explained that he belonged to many engineering organizations and was highly respected in the community of those who specialize in his area of expertise. Juan said that if he wanted to do so, he could call old friends, and the calls would lead to negative publicity for some of his ex-employer’s products, which he believed might cost the ex-employer millions of dollars in lost business. He told me that his ex-employer had not yet woken up to this fact. Juan said that if his ex-employer continued to treat him unprofessionally, he would cause the ex-employer pain, just as the ex-employer was causing pain to him and his family. I told Juan to purge the emotion from his thinking and focus on the best way to achieve his goal, which he had repeatedly told me was a “decent” severance agreement. I advised Juan to call his boss’s manager, with whom Juan was on good terms, and ask for a 1:1 meeting. I explained that companies often offer severance in return for a release and that the senior manager might be more willing to provide severance. Juan agreed to try. He called, but was put into voicemail. Thereafter, Juan received an e-mail from the senior manager explaining he was too busy to talk and giving Juan the name and number of the company’s lawyer. Corporate counsel and I began by discussing our respective clients’ poor handling of Juan’s employment termination. Then we discussed business, talking pleasantly about Juan’s career path and his life in the engineering community. I asked corporate counsel to check on Juan’s reputation in the industry. I also presented Juan’s commercially reasonable severance demand. Corporate counsel told me he would get back to me.


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A few days later, corporate counsel called to tell me that the company was interested in smoothly transitioning Juan out of the company. Thereafter, we quickly negotiated a severance agreement acceptable to both parties.

§ .. the employer’s leverage The employer also has leverage in a separation negotiation. The employer’s leverage must be assessed to understand the power of the employer’s “push back” during the negotiation. The employer’s leverage begins with the at-will nature of most employment relationships. Where no contractual obligation requires the employer to pay severance, the employer is not obligated to provide a separation agreement. Furthermore, the employer usually has deeper pockets than its departing executive; thus, it usually has the financial wherewithal to back up a “no separation benefits” or “no more separation benefits” position, should it choose to do so. Beyond these factors, the employer may also have additional legal and business leverage in the separation negotiation that may cause the separating executive serious concern. § 9.4.4.1 Does the Employer Have Legal Claims Against the Separating Executive? The employer may have potential legal claims against the departing executive arising from the ordinary course of dealing during the employment relationship. For example, the employer may have a reimbursement claim for a draw or advance paid to a departing sales executive. As another example, the employer may have a claim for repayment of an outstanding loan against an executive who has borrowed money from the company. In these situations, the separation negotiation may not revolve around the size of the executive’s severance but rather whether, and to what extent, the employer will forgive the executive’s outstanding debt. § 9.4.4.2 The Entrepreneur’s Surprise—The Employer’s Right to its Intellectual Property Many entrepreneurs (especially founders) are often surprised to discover that the employer firing them owns all the intellectual property that the entrepreneurs created during their employment. The realization that “their” work-related computer files and other data belong to the company they founded, not to them, comes hard for some entrepreneurs. Employment law and the CIIAA usually ensure that the employer owns all of the intellectual property conceived or created by the entrepreneur during his employment. In addition, as part of the incorporation and early financing process, founders typically assign to their company all company-related intellectual property that the founders owned pre-incorporation. Consequently, the employer almost always has a right to

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demand the immediate return of company-related intellectual property and a corresponding right to ensure that the departing entrepreneur retains none of its confidential information and trade secrets. The law, discussed in greater detail in § 10.4, is very protective of a company’s intellectual property. This means that separating entrepreneurs cannot retain their company computer (or any other company property) as leverage to negotiate a better separation agreement. Retaining an employer’s property, in the face of an employer’s insistence that the property be immediately returned, almost always decreases the entrepreneur’s and increases the employer’s leverage on departure. If, before or during a separation negotiation, the employer demands the immediate return of its confidential information and trade secrets, usually the executive should expeditiously return the information.14 § 9.4.4.3 The Employer’s Business Leverage The employer’s business leverage in separation negotiations frequently devolves from whether, and to what extent, the executive perceives he “needs” the employer or one or more of the employer’s directors or officers in the future. For example, the employer will probably have more business leverage over a separating executive who believes the employer’s positive reference is critical to his ability to find a new job than over an executive who does not need the ex-employer for his resume or references. The executive who does not want to “burn any bridges” may settle earlier in the negotiation, and for less separation pay, to ensure no bridge is burned. Some entrepreneurs and executives worry that their employers may “blackball” them if their departures do not go as the employers planned. The “blackball” concern is often not based in reality. The ex-employer frequently has no desire to blackball anybody, and no desire to spend the resources necessary to do so. Moreover, many employers have a policy prohibiting their companies and employees from providing references to third parties inquiring about departed employees. Even if the employer, or one or more of its directors or officers, would like to blackball its departing executive, the employer often does not have the ability to execute on this desire. This is especially true with respect to executives with excellent references from prior jobs. In addition, in certain areas of the country and in certain industries, there are those who would hire a blackballed executive simply because a particular company or individual is doing the blackballing. Nevertheless, there are undoubtedly circumstances, regions of the country, and industries where blackballing is a legitimate concern. If your client raises the concern, it is imperative that you understand the executive’s situation, the market in which he lives and works, and how the concern may affect his separation negotiation.

14

In many “friendly” or “professional” separation negotiations, the separating (or separated) executive will not be pressed (or required) to return the company’s property until he signs the separation agreement.


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§ .. erisa severance plan Unless there are extenuating circumstances (such as a strong legal claim against the employer), it is often difficult to obtain added severance benefits from employers who grant severance pursuant to an ERISA severance plan. As a policy matter, the employer adopted the ERISA plan to standardize and streamline employee departures and will train its managers to treat all departing employees equally under the plan. Even more difficult still is obtaining added severance benefits when a separation agreement is offered pursuant to an ERISA plan during a layoff or mass termination, particularly those that qualify under the federal (or state equivalent) WARN Act.15 The employer will resist deviating from the ERISA plan package, in part to avoid claims from other departing employees that they were discriminated against on termination because they were not given equivalent benefits. § .. the letter to the executive Just as you should write a letter to your executive client regarding his employment agreement, you should also send him a letter about his separation agreement. At a minimum, the letter should contain an analysis of all significant clauses in the proposed separation agreement and your comments and suggestions regarding his separationrelated documents. Your letter will help focus your executive and give him all the information he needs to coldly and calculatingly determine which clauses, and to what extent, he wants to negotiate. This chapter’s appendix includes an example of a letter to an executive regarding a separation agreement. § .. the lawsuit Very rarely should either you or your executive client threaten to file a lawsuit while negotiating a severance agreement. Everyone understands the specter of a court (or arbitration) fight exists, without anyone saying anything. Explicitly threatening a lawsuit may destroy a “friendly” severance negotiation, causing needless conflict. However, the fact that you are an experienced litigator, without one word being mentioned about your experience, may positively impact the severance negotiations. The employer will recognize the added risk an experienced trial attorney brings to the negotiations. If the employer “knows” you and your client are “serious,” it will probably treat you that way. Furthermore, if you are comfortable in the courtroom, your executive client will probably feel a certain sense of security knowing you can support him in court

15

Worker Adjustment and Retraining Notification Act, 29 U.S.C. §§ 2101, et seq.

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(or arbitration) should he need the support. And he may be more willing to listen to your practical advice, knowing you understand how the judicial system works. Severance negotiations are not always successful, or at least, not always immediately successful. It may be necessary for the executive to file a lawsuit or arbitration demand either to obtain his employer’s attention, or alternatively, because the employer has considered the situation and desires to fight. With respect to the former situation, some employers may require the executive with “above average” severance demands to file a claim to test the executive’s resolve. With respect to the latter situation, employers fight when they believe they are in the right or for other considered reasons. Cases do go to trial, and the executive should be prepared for this eventuality if he decides to file a lawsuit. Employers sometimes act economically irrationally, refusing to negotiate when any “reasonable” man would and should negotiate. This situation may occur when an unchecked executive, board member, or investor of the employer acts emotionally, deciding to use corporate funds to “prove a point” to the departing executive. Sometimes defense counsel is complicit in the emotional decision making, but other times the employer’s attorneys do their best to stop the train wreck. In any case, a lawsuit may be required to resolve the situation.16 Executive Story “We gave your name to Peritus,” a leading intellectual property lawyer said to me as our conversation began. “It’s an unusual situation,” he continued. “Peritus is a repeat public company CEO. He is very successful, and we represent him in a complex intellectual property matter. The other side has alleged damages in the hundreds of millions of dollars. The company is separately represented and is paying for Peritus’s attorneys’ fees under his indemnification agreement.” “Peritus now has a problem with the company, which our labor attorneys tried to work out. It’s ridiculous they are fighting, but one of the company’s key institutional investors has this thing for Peritus. We told Peritus we won’t represent him against his employer. It’s just not what we do.” My first question to Peritus when he walked into my office: “What dysfunctionality is causing this dispute?” Given the circumstances, the parties should have expeditiously and privately worked out their differences. Peritus had nothing to do with the alleged intellectual property issues at the employer, left his employer voluntarily, and demanded payment of approximately $5 million in

16

It is also possible that your executive or entrepreneur client may want to act economically irrationally. Hopefully your skills will prevent this from happening.


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performance bonuses that were payable unless his employer terminated him for cause. Presumably at the behest of the institutional investor, the employer refused to pay Peritus his performance bonuses on the grounds that Peritus had covered up reasons for the employer to terminate Peritus’s employment for cause. The company had uncovered the hidden facts after Peritus’s departure, alleged the employer. Left with no choice and loath to forego $5 million, Peritus filed a lawsuit against his former employer. The employer fought, and the parties battled in court for a while. At some point, Peritus decided that enough was enough. He started calling his money manager friends, one of whom knew an individual responsible for investing significant funds in the institutional investor. The friend of a friend called the institutional investor and explained that he was “deeply concerned” with the possibility that it was losing its focus. Shortly thereafter, the employer sensed a shifting in the winds at its key investor. The employer’s new CEO called Peritus and asked him why they were fighting. It took only a few minutes for the principals to settle the case.

§ 9.5 Anatomy of a Separation Agreement

This section describes the most common separation-specific clauses in an executive separation agreement. The separation agreement may contain many other provisions not discussed below, including those discussed in earlier chapters. Choice of law; venue and integration; no mitigation; arbitration; waiver; severability; non-disparagement and other clauses that are similar, if not identical, to those described in § 7.4.22–§ 7.4.32, under anatomy of an employment agreement, are commonplace in separation agreements. § .. departure clause: termination vs. resignation Most executives prefer that their separation agreements state they resigned their employment, regardless of how or under what circumstances they departed. If they were fired, only a minority of executives will want the separation agreement to state they were involuntarily terminated. It does not cost the employer anything to agree to the executive’s characterization of his departure, and most employers will agree to include resignation language in the separation agreement. Some employers, however, prefer the neutral, “Executive’s employment terminated on [Date].” If your executive client wants his separation agreement to state that he resigned, you should ensure the language will not void his unemployment insurance claim (if he plans to file one). An involuntary termination of employment without cause should

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qualify the unemployed executive for unemployment insurance benefits, whereas, a voluntary termination of employment (e.g., a true resignation) may not.17 In many situations, resignation language in a separation agreement may not bar unemployment insurance benefits where the facts show that the employer involuntarily terminated the employee or that the executive had no reasonable possibility to continue working for the employer.18 However, in some cases, resignation language in the separation agreement may be used by an employer to dispute an employee’s right to unemployment insurance benefits.19 In states where the unemployed essentially qualify for unemployment insurance benefits unless the employer disputes the claim, adding the following clause to the separation agreement should protect the executive: “The Company agrees Executive is entitled to unemployment insurance benefits and shall not oppose Executive’s application for unemployment insurance benefits.” Some employers prefer more neutral language, such as “The Company agrees that it shall not oppose executive’s truthful application for unemployment insurance benefits.”20 § .. separation payments The separation agreement’s payment clause describes the payments the employer will make to the executive. Severance pay may be described as a gross amount (e.g., “The

17

See, e.g., Mass. Gen. Laws ch. 151A, § 25(e)(1) (unemployment benefits unavailable “after the [employee] has left work voluntarily unless the employee establishes by substantial and credible evidence that he had good cause for leaving”); Minn. Stat. § 268.095 (disqualifying from unemployment benefi ts employees who quit without employer-caused good reason; an employee “quit” occurs whenever the decision is the employee’s, even if the employee has been told he will be discharged); N.Y. Lab. Law § 593(1)(a) (denying unemployment benefits for “voluntary separation without good cause”); Or. Rev. Stat. § 657.176(2)(c) (disqualifying employees from unemployment benefits where they “voluntarily left work without good cause”). 18 See, e.g., Smith v. Unemployment Appeals Comm’n, 823 So.2d 873, 874 (Fla. Dist. Ct. App. 2002) (requiring employee to “establish facts to show the employee was faced with certain discharge or loss of job” to qualify for unemployment benefits); Cordoba v. Beau Dietl & Assoc., No. 02 Civ. 4951(MBM), 2003 WL 22927874 at *3 (S.D.N.Y. Dec 2, 2003) (employee qualified for unemployment insurance despite settlement agreement clause requiring employer to provide employment reference saying employee resigned). 19 See, e.g., Andrist v. City of Wanamingo, No. A03–1262, 2004 WL 614744, at *1 (Minn. Ct. App. March 30, 2004) (employee ineligible for unemployment benefits where employee was told she would be discharged, signed severance agreement saying “she enters this Agreement freely and voluntarily” and consented to board vote on her resignation); Burton v. Emp. Div., 755 P.2d 723, 724 (Or. Ct. App. 1988) (term employee who agreed to shorten term at employer’s request did not qualify for unemployment benefits because “separation papers indicated that [employee] resigned” and because employee could have insisted on remaining employed longer). 20 The separation agreement should avoid any suggestion that separation payments are made in lieu of wages. See Meakins v. Huiet, 112 S.E.2d 167, 169–70 (Ga. Ct. App. 1959) (distinguishing “severance pay” from “wages in lieu of notice”); DiCerbo v. Comm’r of Dep’t of Emp. and Training, 763 N.E.2d 566, 571 (Mass. App. Ct. 2002) (when severance package is a lump sum payment in consideration for a release and with no employment-related contingencies, the payment is not “remuneration” and does not disqualify the employee from unemployment benefits).


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Company will pay Executive $50,000”) or in terms of a number of months of base salary (e.g., “The Company will pay Executive six months of base salary”). Prorated (or full) bonuses and other benefits are sometimes included as severance. Traditionally, severance is paid either (i) in one lump sum payment or (ii) over time. Severance may take the form of “salary continuation benefits.” “Salary continuation benefits” are payments (usually base salary) that the former employer makes to the terminated employee for a set period of time. Salary continuation benefits may be contingent on the employee being unemployed or contingent on the employee not working for a competitor. The contingent salary continuation benefits may terminate if the employee starts work at another employer or goes to work for a competitor before the salary continuation benefits expire. Separation payments almost always begin after the effective date of the separation agreement’s release. A clause should be included in the separation agreement that establishes a deadline for payment (or the first payment) of the severance benefits. Arm’s-length negotiated separation agreements should not implicate § 409A unless the separation payment is substituting for § 409A-compliant deferred compensation.21 This is so because the legally binding right to receive severance and the vesting of the right to receive severance (the removal of the substantial risk of forfeiture of obtaining the back-end separation agreement) occurs on the day the separation agreement is signed. If the severance payment (e.g., lump sum payment) is made within two and one-half months of the end of the taxable year in which the separation agreement is signed, the separation payment qualifies under § 409A’s short-term deferral exemption, and the payment will not be classified as deferred compensation.22 If separation payments or benefits are paid in installments, then the payment clause must be drafted to ensure that it is § 409A compliant.23 § .. outplacement clause The separation agreement’s outplacement clause describes the outplacement services that the employer will provide post-employment. Not all employers provide outplacement services. When outplacement services are provided, executives sometimes attempt to negotiate for an additional payment (equal to the employer’s cost of providing outplacement services) in lieu of outplacement services. The following clause may be added to accomplish this: “Company shall pay Executive [$___________] in lieu of providing outplacement services to Executive.”

21

Treas. Reg. § 1.409A-1(b)(9)(iii); Treas. Reg. § 1.409A-1(b)(9)(i) (separation payment made “as a substitute for, or replacement of, amounts deferred by the [employee] under a separate nonqualified deferred compensation plan constitutes a payment or a deferral of compensation”). 22 Treas. Reg. § 1.409A-1(b)(4)(i)(A). 23 § 409A should not apply to most settlement agreements resolving legitimate employment-related disputes. Treas. Reg. § 1.409A-1(b)(11).

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§ .. cobra/medical benefits The COBRA/medical benefits clause in a separation agreement describes the COBRA or state-equivalent benefits the employer will pay on behalf of the departing employee. Employers regularly provide paid COBRA benefits for the same number of months as they provide severance. For example, the employer providing six months of severance pay will often provide six months of paid COBRA benefits.24 § .. reimbursement of business expenses The reimbursement of business expenses clause in a separation agreement lists the amount of the as yet unreimbursed business expenses that the employer will pay the departing executive. Even though the exiting executive may be entitled to reimbursement of his business expenses under the employer’s expense reimbursement policy (and under law), to avoid confusion and to protect against the possibility that the separation agreement’s release might release the executive’s right to reimbursement, this clause should state the amount of the expenses to be reimbursed and the date when payment will be made. § .. accelerated vesting/equity clause The separation agreement’s accelerated vesting/equity clause describes the amount of accelerated vesting (or other equity consideration or benefits) the employer will provide the departing executive. The following is an example of a stock option acceleration clause: “Fifty percent (50%) of executive’s unvested employee stock options shall immediately vest and become fully exercisable.” § .. post-termination exercise extension clause The separation agreement’s post-termination exercise extension clause describes the additional time the executive is given to exercise his vested employee stock options.25 Executives separating from private companies often do not want to spend the money to purchase their stock options until they determine whether new management will be successful. However, private employers are often unwilling to grant posttermination exercise extensions during back-end severance negotiations.

24

See discussion in § 7.4.18.6.2 regarding COBRA. The federal government reimbursed 65 percent of employees’ COBRA premiums for employees whose employment was involuntarily terminated between September 1, 2008, and May 31, 2010. The terminated employees were required to pay 35 percent of their COBRA premiums, and their employers were required to advance the remaining 65 percent, which qualified as a tax overpayment. The government reimbursed employers up to nine months of employeradvanced COBRA payments. American Recovery and Reinvestment Act of 2009 (ARRA), div. B. § 3001, Pub. L. No. 111–5, 123 Stat. 115 (2009) (codified as amended at 26 U.S.C. § 6432). 25 See Treas. Reg. § 1.409A-1(b)(5)(v)(C)(1). ISOs not exercised within three months of the employment termination date lose their ISO status and become NQSOs.


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§ .. property retention clause The separation agreement’s property retention clause lists the employer’s property the employee may keep after the termination of his employment. Employees often want to retain employer-provided computers, peripherals, mobile phones, or other electronic (or nonelectronic) devices. All items the parties agree the employer may keep must be written into the separation agreement. The items’ value should also be included in the property retention clause. If the executive is keeping his computer or other electronic storage device, the computer or device should be provided to the employer to enable the employer to remove its confidential and propriety information and trade secrets. In the event the employer does not insist on inspection, a statement should be included in the separation agreement confirming that the executive will provide the computer to the employer for inspection. Thereafter, the executive should do so. This will help protect the executive against a later claim that the executive illegally retained his former employer’s confidential files on his computer.

§ .. attorneys’ fees reimbursement clause The separation agreement’s attorneys’ fees reimbursement clause sets out the employer’s obligation with respect to paying the attorneys’ fees the executive incurs for review and negotiation of the separation agreement. Some employers will pay part or all of the attorneys’ fees that their departing executives incur during their separation.

§ .. representation regarding payment of compensation and benefits Separation agreements frequently include a clause by which the executive represents that the employer has paid or provided all compensation, equity, and benefits owed to the executive, other than the payments and benefits set forth in the separation agreement. The employer includes this clause because it wants the executive’s representation that once the separation agreement’s release becomes effective, and the employer makes the payments and provides the benefits set out in the separation agreement, the employer has no further obligation of any kind to the executive.

§ .. continuing agreements clause The separation agreement’s continuing agreements clause lists all agreements that will continue in effect after the separation agreement becomes effective. The clause almost always confirms that the executive’s CIIAA will continue in full force and effect. Employers strictly guard their confidential and proprietary information and include this clause to ensure the separation agreement’s integration clause does not vitiate the CIIAA. Guaranteeing the employer’s continuing obligation to indemnify the executive post-separation is often critical to the executive. Consequently, if an indemnification

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agreement exists, the continuing agreements clause should also confirm that the employer’s contractual obligation to indemnify the executive will survive the termination of the executive’s employment.26 § .. release and carve-outs The release is often the most important consideration the employer receives in a separation agreement. Releases, carve-outs to releases, and California’s § 1542 clause are discussed in §§ 7.4.19, 7.4.19.1, and 7.4.19.2. Typically, employers draft their separation agreements with one-way releases (executive releases the employer). The executive may be better off if a mutual release of claims is included in the separation agreement. A mutual release of claims provides that the employer releases the executive from all known and unknown claims just as the executive releases the employer. During back-end severance negotiations, many employers refuse to provide mutual releases to their departing executives. These employers fear the possibility of undiscovered wrongdoing. Many of these employers will agree, however, to represent in the separation agreement that they have no present intention of suing the executive. § .. covenant not to sue Employers sometimes insert a covenant not to sue into the separation agreement. The covenant usually obligates the departing employee not to sue his ex-employer for any claim the employee has released under the separation agreement’s release.27 In the event the employee sues the employer and breaches the covenant, the employer may file a countersuit to recover the attorneys’ fees it incurs defending the lawsuit. The covenant not to sue may also provide that if the employee breaches the covenant, the employee must return part or all of the separation payments and benefits he received under the separation agreement. A covenant with this type of requirement is a forfeiture (or clawback) clause.28 Whether and to what extent a court will award damages for breach of a covenant not to sue depends on the court and the facts of the case.29 Even where it might be

26

The executive’s equity agreements may be listed in the continuing agreements clause, but because the separation agreement often includes references to the executive’s equity, it is often unnecessary to include them in this clause. However, the surviving equity agreements should be referenced (or listed) as surviving agreements in the separation agreement’s entire agreement-integration clause. 27 As explained in § 9.5.15, for a release to be effective in waiving all Age Discrimination in Employment Act claims, it cannot require the employee to return benefits he received for signing the release if he later challenges, in good faith, the validity of the release under the ADEA. Consequently, the covenant not to sue should specifically provide that it does not prevent the ex-employee from suing for this purpose. 28 Forfeiture provisions are discussed in greater detail at § 7.4.19 and § 9.5.22. 29 Compare McKissick v. Yuen, 618 F.3d 1177, 1183, 1199 (10th Cir. 2010) (ex-employee’s lawsuit against ex-employer and its executives precluded by severance agreement’s covenant not to sue; ex-employee


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unenforceable, or damages for breach limited to a shifting of attorneys’ fees, the covenant not to sue will probably have a chilling effect on any employee considering suing in violation of the covenant. § .. workers compensation issues The ability to release rights to workers compensation benefits in a release negotiated outside the workers compensation system is a function of state law. In many states, an employee cannot release his right to workers compensation benefits via a privately negotiated general release.30 Workers compensation law is specialized. If you do not know the effect of a general release on your client’s workers compensation benefits claim, then consult a practitioner in your state who specializes in the field. In any event, if your client has a workers compensation claim, the safest approach is to include a carve-out in the separation agreement for the employee’s right to claim workers compensation benefits. § .. time to consider the separation agreement Although the employer is well advised to give its employees some time to consider the separation agreement, in many states employers are not legally required to provide employees under 40 years of age any specific period of time to consider their separation agreement.31

must pay employer’s but not employer’s executives’ attorneys’ fees incurred defending lawsuit), and Astor v. International Business Machines Corp., 7 F.3d 533, 540 (6th Cir 1993) (reversing district court and awarding reasonable attorneys fees to employer because employees breached covenant not to sue), with PFPC Worldwide Inc. v. Lemay, 2005 WL 2176828 (W.D. Pa. 2005) (former executive’s involvement in lawsuit against ex-employer for minority shareholder relief breached covenant not to sue, triggering agreement’s forfeiture provision and requiring repayment of over $208,000 former executive received under separation agreement), and Rosser v. Raytheon Excess Pension Plan, 2008 WL 4791494, *11 (N.D. Tex. 2008) (employee who violated covenant not to sue required to return $142,155.20 “which represents the amount of special benefits [ex-employee] received in consideration of his waiver and release”). 30 See e.g., Ariz. Rev. Stat. Ann. § 23–1025 (waiver of right to compensation or agreement to pay employer’s workers compensation premium void, except as permitted by workers compensation statutes); Cal. Lab. Code § 5001 (“No release of liability or compromise agreement [in a workers compensation matter] is valid unless it is approved by the appeals board or referee”); Conn. Gen. Stat. § 31–296 (workers compensation agreements must be submitted with detailed information to the Commissioner to be effective); Ind. Code § 22–3-10–1 (all releases outside workers compensation system null and void); N.J. Stat. Ann. § 34:15–39 (any agreement or release of damages made before injury is invalid). 31 See Gruver v. Midas Intern. Corp., 925 F.2d 280 (9th Cir. 1991) (rejecting argument that plaintiff had insufficient time to contemplate termination agreement as an insufficient claim of duress); Bormann v. AT&T Communications, Inc., 875 F.2d 399, 402–03 (2d Cir. 1989) (“knowingly and willfully” is a common law standard, one element of which is “the amount of time the plaintiff had possession of or access to the agreement before signing it,” and not specifying any minimum amount of time); Hyde v. Lewis, 323 N.E.2d 533, 538 (Ill. App. Ct. 1975) (termination agreement release binding “as long as [employee] had ample time for inquiry, examination and reflection”).

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Almost every separation agreement offered to departing employees 40 years of age or older provides that the employee may consider the separation agreement for at least 21 days. This is so because of the federal Age Discrimination in Employment Act (ADEA), which protects employees 40 years of age and older against age-based employment discrimination.32 For a release to be effective against a statutory ADEA age discrimination claim, the employer must (i) provide the employee 21 days to consider the release, (ii) advise the employee in writing to consult with an attorney prior to executing the agreement, (iii) provide the employee seven days to revoke the release, (iv) advise the employee in writing that the release is effective only to release acts or omissions that occurred on or before the day the executive signs the release;33 and (v) not require the employee to return benefits he received for signing the release if he later challenges, in good faith, the validity of the release under the ADEA.34 If the employee is terminated as part of a reduction in force, the employee must be given 45 days to consider the release.35 The employee is not required to wait 21 days (or 45 days) before signing the release. He may sign at any time within the period, and by so doing waives the remainder of the consideration period. The seven-day revocation period runs from the date the ex-employee signs the release.36 § .. non-compete clause Where permitted, the separation agreement’s non-compete clause provides that the employee may not compete against the ex-employer, typically for a set period of time in a geographic area. Non-compete agreements and clauses, and California’s prohibition against non-compete clauses, are discussed in Chapter 10. § .. confidentiality clause Except in the case of officers and directors of publicly traded companies whose severance agreements must be publicly disclosed, employers regularly seek to restrict dissemination by the former employee of the terms and conditions of the separation agreement. The confidentiality clause in a separation agreement restricts the executive

32

29 U.S.C. §§ 621–634. 29 U.S.C. § 626(f)(1). A release that does not conform to the statute’s requirements will be invalid. Oubre v. Entergy Operations, Inc., 522 U.S. 422 (1998) (because release did not comply with ADEA statute, ADEA lawsuit was not precluded by release and employee could sue and retain severance pay). 34 29 C.F.R. § 1625.23. 35 29 U.S.C. § 626(f)(1)(F)(ii). The ADEA requires 45 days’ notice when “waiver is requested in connection with an exit incentive or other employment termination program offered to a group or class of employees . . . .” Id. 36 Employees who are part of a layoff covered by the WARN Act or similar state statute must be given 60 days notice of the termination of their employment, although the WARN Act does not require the employer to offer a separation agreement. 29 U.S.C. § 2102(a). 33


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from disclosing the separation agreement and its terms and conditions to the individuals or entities listed in the confidentiality clause. Typically, the employer’s initial draft agreement will permit the departing executive to disclose the information only to the executive’s spouse or immediate family members, his attorneys, and tax advisors and perhaps as otherwise required by law (e.g., in response to a subpoena). The employer’s initial proposed term might read, “You agree that you will not disclose to others the existence or terms of this Agreement, except that you may disclose the information to your spouse, attorney, or tax advisor if these individuals agree that they will not disclose to others the existence or terms of this Agreement.” Most employers’ disclosure lists are excessively narrow. At a minimum, in addition to those whom the employer permits disclosure, the executive should be allowed to disclose the terms and conditions of his separation agreement to his financial advisors, banks and other financial institutions, and any government entity that requests a copy of the agreement. The executive should be able to disclose his separation agreement to financial advisors because he may need to do so to obtain financial advice. The executive should be able to disclose the separation agreement to banks and other financial institutions in case doing so is necessary to obtain a loan or other financial product. The executive should be able to disclose his separation agreement to any government agency that requests a copy to enable him to voluntarily cooperate with any interested government agency (e.g., the IRS or SEC). Voluntarily cooperating with an interested government agency is often a better course of action than requiring the agency to issue a subpoena. Employers will usually not object to these additions. The clause discussed above should thus be expanded to read, “You agree that you will not disclose to others the existence or terms of this Agreement, except that you may disclose the information to your immediate family members, attorneys, tax advisors, financial advisors and banks or financial institutions, if the individual or entity receiving the information agrees that he or it will not disclose to others the existence or terms of this Agreement, and to any government agency which requests a copy of this Agreement, and as otherwise required by law.” § .. non-disparagement clause Employers frequently include a non-disparagement clause in their separation agreements. Most employers will agree to make the non-disparagement clause mutual if the executive requests a two-way non-disparagement clause, although they will often refuse to take responsibility for the comments of their non-officer employees. Consequently, many non-disparagement clauses prohibit the executive from disparaging anyone or anything associated with the employer but only prohibit the employer’s officers and directors from disparaging the executive. The executive must carefully consider the non-disparagement clause and the effect it may have on his future career. A broadly drafted non-disparagement clause may cause difficulties for the executive if he someday accepts a position at another employer where critiquing the former employer’s products is part of his job description.

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Non-disparagement clauses are contractual commitments prohibiting one party from saying bad things about the other party, although the meaning of “non-disparagement” is often open to interpretation.37 Contractual non-disparagement clauses do not vitiate state defamation law. If a party makes untrue statements of material fact that cause another damage, that party may be liable, depending on the state and circumstances, for defamation, slander, and/or libel, regardless of whether a contractual non-disparagement clause is included in a separation agreement.38 § .. third-party reference clause The third-party reference clause describes the way in which the employer will respond to third-party inquiries about its former executive (for example, a reference check from a prospective employer). Many employers have a policy that they will disclose (or confirm) to third parties only their former employee’s dates of employment, final pay rate, and final position. Sometimes, however, an employer will provide a letter of reference or agree to direct third-party inquiries to one or more individuals who will provide a specific statement to those who are interested. When a senior executive is confident that he will receive a positive reference from another senior executive or director of his former employer, he may choose to forego negotiating for the inclusion of a third-party inquiry clause in his separation agreement. Typically, the executive decides, as a personal or business matter, to leave the trusted reference out of his departure negotiations but assumes the positive reference will be forthcoming (and takes the risk it will not). Executives desiring or depending on positive references from their ex-employers are often better off negotiating the content of the employer’s communication. Once the parties agree on the language, the employer’s commitment should be written into the separation agreement. Doing so obligates the employer to respond as agreed.

37

See Patlovich v. Rudd, 949 F. Supp. 585, 595 (N.D. Ill. 1996) (defining “disparage” according to “ordinary principles of contract interpretation,” rather than commercial disparagement law, and concluding Webster’s definition (“to speak of in a belittling way; to reduce in rank or esteem”) is appropriate in the context of the contract); Eichelkraut v. Camp, 513 S.E.2d 267, 269 (Ga. Ct. App. 1999) (looking to the “intent of the parties” to conclude that the non-disparagement clause “applied to all derogatory communications, whether true or not,” despite state statute defining “disparagement” in the context of slander). 38 “Defamation” may be referred to in various ways. For example, in California, defamation is an overarching category of untruthful statements of material fact that give rise to damages. It is either libel (written) or slander (oral), and the cause of action would typically be labeled “libel” or “slander,” not “defamation.” Cal. Civ. Code §§ 44–46. Some states define defamation, libel, and/or slander by statute. See, e.g., Colo. Rev. Stat. § 18–13–105 (defining “criminal libel”); Ga. Code Ann. §§ 51–5-1 (defining “libel”), 51–5-4 (defining “slander”); Idaho Code Ann. § 18–4801 (defining “libel”). Other states define defamation, libel, and slander partially or completely through case law. See, e.g., Harris v. School Annual Pub. Co., 466 So.2d 963 (Ala. 1985) (defining “defamation”); Rouch v. Enquirer & News of Battle Creek Michigan, 487 N.W.2d 205 (Mich. 1992) (listing elements of defamation).


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Similarly, if the employer agrees to provide a letter of reference, the letter should be attached as an exhibit to the separation agreement. Otherwise, the release contained in the separation agreement will release the employer from any obligation to deliver the reference letter. § .. cooperation clause The employer may include a cooperation clause in the separation agreement that requires the executive to cooperate with the company in certain future circumstances, typically situations where the employer is involved in litigation. For example, if the executive is a key witness in or knowledgeable about the litigation, the company may want the opportunity to meet with the executive to discuss the facts underlying the dispute. To protect the executive, the cooperation clause should provide that cooperation under the clause will not negatively affect the executive’s future employment or consulting relationships. In addition, the clause should require the company to pay all out-of-pocket costs the executive incurs if he is asked to cooperate. The clause should also require the ex-employer to pay the executive a consulting fee for the time he is required to devote to the company under the clause, especially where the executive has received a lump sum separation payment or the last of a series of separation payments (e.g., salary continuation payments). If the executive receives salary continuation payments as part of his separation, the employer may consent to pay a consulting fee only for cooperation provided after the end of the salary continuation payments.

§ .. no admission of liability clause The employer often includes a no admission of liability clause in the separation agreement. The clause provides that neither the separation agreement nor payments and benefits provided under the separation agreement constitute an admission of liability or wrongdoing by the employer.

§ .. forfeiture (clawback) clause Some employers seek to add automatic forfeiture (clawback) clauses to their separation agreements. These clauses typically provide draconian penalties in the event the executive breaches the separation agreement. Many forfeiture clauses provide that any breach of the separation agreement by the executive will be deemed a material breach. Thereafter, the clauses may require that, in the event the executive breaches the contract, he immediately return all, or a substantial part of, the consideration received under the separation agreement. For example, a forfeiture clause might provide, “If Executive breaches any of Executive’s obligations under this Agreement, Executive shall immediately forfeit to the Company all cash

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payments and the value of all benefits received under this Agreement.” Where the separation agreement requires the employer to make continuing payments to the separated executive, in the event the executive breaches the agreement, the forfeiture clause will probably provide that the ex-employer has no further obligations to make the payments. Whether, and to what extent, forfeiture clauses are enforceable depends on the wording of the clause at issue and the governing law of the contract.39 Even if the forfeiture clause is unenforceable, it may have a severe chilling effect on the executive, and, if litigation occurs, may turn what otherwise would be a frivolous employer claim into a non-frivolous one. From the employer’s perspective, the goal of the forfeiture clause is to increase the pressure on the departing executive to strictly follow the terms of the separation agreement. The employer is often most concerned about the departing employee continuing to abide by his confidentiality obligations and honoring both the separation agreement’s confidentiality and release clauses. In addition, the employer may also be concerned that proving breach of contract will be difficult and expensive. From the executive’s perspective, the forfeiture clause is abusive. To protect the executive, all forfeiture clauses should be removed from the separation agreement. The executive should not forfeit all of his consideration in the event he commits a minor or immaterial breach of the separation agreement. If the executive breaches the separation agreement, then the employer should be required to prove material breach of the agreement and damages, and, if it can do so, then it should be able to recover damages. § .. representation by counsel clause The representation by counsel clause provides that each party to the separation agreement has retained independent counsel. The clause also frequently provides that in making their decisions to enter into the separation agreement, neither party relied on any representations of the other party except for those representations specifically set forth in the separation agreement. § .. other clauses and benefits A separation agreement is a contract. Consequently, if a clause is legal, it can be written into the contract. As the executive’s attorney, you must be prepared to calibrate (or recalibrate) your client’s expectations but also ready to negotiate special or unique clauses or benefits into the separation agreement.

39

See § 9.5.13 and § 10.3 and the cases discussed in the footnotes to these sections.


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Appendix Example of a Letter to Client Regarding a Separation Agreement Letters regarding separation agreements, as with letters about employment offers, must be individually written. Although genres of situations repeat themselves, every executive’s situation is unique, even if the executive’s separation happens as part of a reduction in force. While many of the same comments, suggestions, and warnings may appear in your letters, you must revise each letter for each executive and entrepreneur. Following is a sample draft letter to an executive regarding his separation from a private employer. The scenario is of a “friendly” separation, where the exiting executive is negotiating the terms of his departure while still employed and has no interest in suing his former employer. Because the executive is uninterested in potential legal claims against his employer, this letter does not discuss the potential claims. If potential legal claims are present, and the executive is interested in pursuing the claims, then it may be appropriate to discuss them in the letter. *** Date40 VIA E-MAIL Mr. Executive Address City, State Re: Your Draft Separation Agreement Dear Mr. Executive, As you requested, I reviewed the Separation and General Release Agreement (“Separation Agreement”) you received from your employer, Company, Inc. (“Company”), regarding the termination of your Company employment.

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The author retains the copyright to this example letter.

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In addition to the Separation Agreement, I also reviewed copies of: • Your signed Confidential Information and Invention Assignment Agreement (“CIIAA”); • Your signed Company Offer Letter; • Your signed Company equity agreements and the applicable Company equity plans; • Your chronology of events; and, • [ _______________________ ]. You have not sent me any other Company employment-related agreements or documents. Obviously, I cannot comment on documents I have not seen. Among other documents, the Separation Agreement references the Company’s [ ___________ ], [ _____________ ], and [ ___________ ]. I urge you to send me these documents, as well as any other employment-related agreements/documents, for my review before you sign your Separation Agreement. These documents may contain terms material to your separation from the Company. If the terms of these documents (or any other documents or oral agreements) materially affect any of the terms of your Separation Agreement, or your departure from the Company, then my comments and suggestions below might be very different from the comments and suggestions I would give you with full information. Separation Agreement My comments and suggestions regarding your Separation Agreement are below. The numbers to the left correspond to the sections of the Separation Agreement. § 1 This section states that your “employment termination date” is [ _________ ] (“Separation Date”). Is this characterization acceptable? Would you prefer that this section state you resigned? Is the final date of your employment acceptable? § 2 Your severance compensation is defined in this section. Is the amount of severance acceptable? A date certain (e.g., three days after the Effective Date of the Separation Agreement) for payment of the lump sum separation amount should be added to this section. You are not receiving any part of your [ _______ ] as part of the severance package. Is this acceptable?


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§ 3 The Company is not paying for any part of your COBRA coverage. Companies frequently pay their departing executives the same number of months of COBRA benefits as they pay months of severance. If Company-paid COBRA premiums are important to you, then I suggest that you negotiate for Company-paid COBRA benefits. § 4 This section states that the Company will reimburse you for all ordinary business expenses you submit by [ ________ ]. If you are able to do so, I strongly suggest that you immediately submit all reimbursable expenses to the Company. Thereafter, a clause should be added to the Separation Agreement stating how much you are owed in reimbursable expenses and when you will be reimbursed. § 5 Whether or not you sign the Separation Agreement, on your final day of employment, the Company is required to pay you your final accrued wages and [ ______________ ]. To avoid any possible confusion, I suggest that you add a sentence to the Separation Agreement stating that you will be paid all of your accrued wages and [ ____________ ] on the Separation Date. § 6 In this section, you acknowledge/represent that you have received all accrued but unused vacation and been paid all wages, bonuses, commissions, equity compensation, and any other compensation earned during your employment. Is this statement accurate? If it is not accurate on the day you sign the Separation Agreement, then the representation must be modified so that it is accurate. § 7 This section lists each of your Company stock options and the number of shares subject to each stock option in which you will be fully vested as of your Separation Date. Please confirm that these numbers are accurate. This section also states that your stock options will continue to be governed by the applicable stock option agreements and plans. Each of your options gives you [ ____ ] days after your Separation Date to exercise the option. If you are planning to exercise your stock options, I urge you to exercise the options before the final date to do so in case something goes wrong on the day you intend to exercise. Consider whether you want to attempt to negotiate for (i) accelerated vesting of some portion (e.g., one additional year) or all of your stock options and (ii) an extended post-termination exercise period (e.g., an additional one or two years) to exercise your options. § 8 This section contains a general release of claims pursuant to which you release the Company and a long list of Company-related entities and individuals from all claims, whether you know about them or not, that you may have against the Company and the long list of Company-related entities and individuals. However, the Company is not releasing you from anything. Consider negotiating for a two-way (mutual)

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release pursuant to which the Company, and its officers, directors, and managing agents, release you from all claims they may have against you. Releases are rigorously enforced. Do not sign the Separation Agreement if you may someday want to sue the Company or any of the Company-related individuals or entities listed in the release for any acts or omissions they committed up to and including the day you sign the Separation Agreement. I urge you to add the following carve-outs to the release: “Notwithstanding any other term in this Separation Agreement, the release does not release (i) any of Executive’s rights arising out of this Agreement, (ii) [ _________ ]” Are there any other employee-related benefits to which you are entitled or to which you want to remain entitled after your departure from the Company? If so, list them in the Separation Agreement. [§ 9 This section contains a waiver under § 1542 of the California Civil Code (“§ 1542”). § 1542 protects a person signing a release from releasing claims he does not know about. In this section, you are waiving your rights to the protections afforded by § 1542. You are releasing all the claims discussed above against the Company and the other releasees, whether or not you know about the claims.] § 10 This section requires you to “cooperate” with the Company after the Separation Date concerning any Company-related litigation. In the event cooperation is requested under this section, then consider negotiating for the Company to pay you a consulting fee for all of the time you are required to cooperate. I also suggest adding a clause providing that cooperation under this section shall not in any way affect your future employment or consulting work. § 11 Read your representation and warranty with respect to returning Company property very carefully. Unless you negotiate to retain certain Company property, you must return all Company property to the Company on or before your Separation Date. Consider whether you would like to negotiate to keep your computer, computer peripherals, PDA, or other electronic or non-electronic Company device. Whatever items you negotiate to keep must be listed in the Separation Agreement. § 12 The first sentence of this section contains a one-way non-disparagement clause. Consider negotiating for a mutual non-disparagement clause. Apart from this, consider whether the prohibition against “disparaging” the Company and/or its “products and services” may negatively impact your ability to compete against the Company in the event you some day go to work for a competitor of the


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Company. If you believe the non-disparagement clause might affect your future employment, please speak with me immediately about possible revisions to the clause. § 13 Change this section to read: “Executive shall keep this Separation Agreement and its terms strictly confidential and will not disclose this Separation Agreement or any of its terms, except to Executive’s immediate family members, tax advisors, attorneys, financial advisors or banks or other financial institutions, or to any government agency which requests a copy of this Separation Agreement, or as otherwise required by law.” § 14 Remove this section in its entirety. You should not agree that any breach of the Separation Agreement is a material breach, nor should you agree to return your separation benefits in the event of any breach. If you breach the contract, then the Company should be required to prove material breach and damages. § 15 This section contains an integration and superseding clause. This means that the Separation Agreement supersedes, nullifies, and voids all prior written and oral agreements and contracts between you and the Company, with the exception of the agreements specifically listed in this section. As drafted, the list of surviving documents includes only your equity agreements and CIIAA. Your Company Indemnification Agreement and [ ___________ ] Agreement must be added to this list. If you have any other contracts and/or agreements you do not want nullified, you must list them in this section. Furthermore, if you were promised something as part of your separation negotiations or expect to receive something from the Company after your separation, what you were promised or expect to receive must be written into the Separation Agreement. Otherwise, you will not receive what you were promised or expect to receive. Additional Clauses to Consider Adding to Your Separation Agreement Arbitration Clause: Consider whether you prefer to arbitrate disputes you may have with the Company, rather than litigate them in the judicial (court) system. Arbitration has its upsides and downsides. I am happy to discuss them with you if you are interested. Attorneys’ Fees for Review of the Separation Agreement: Consider negotiating for the Company to reimburse you for the attorneys’ fees you incur in connection with the review and consideration of your Separation Agreement. Some companies will pay the reasonable attorneys’ fees of their departing executives. Attorneys’ Fee Shifting Clause: Consider whether you want to include an attorneys’ fee shifting clause to the Separation Agreement, under which the losing party in a legal dispute pays the prevailing party’s attorneys’ fees and costs. There are upsides and downsides to including an attorneys’ fee shifting clause. Please ask me if you would like further information about an attorneys’ fee shifting clause.

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Characterization of Your Termination: Consider negotiating the way in which the Company will portray your termination internally. No Mitigation Clause: I urge you to add the following clause to your Separation Agreement: “Executive shall have no duty to mitigate any breach of this Separation Agreement by the Company.” A “no mitigation” clause protects you in the event the Company breaches the Separation Agreement after you sign it. Outplacement Services: Consider requesting the Company to pay you an additional payment in lieu of providing you with outplacement services as part of your separation. Some companies provide outplacement services to their departing employees and are willing to pay a departing employee additional money if the employee agrees to forego outplacement services. Third-Party Inquiries: Consider how you want the Company and/or any Company employee or director to respond to potential third-party inquiries, such as requests for references by potential future employers. For example, if future employers call, what, if anything, do you want the Company to say, and who do you want to say it? If you want the Company to respond in a specific way to third-party inquiries, then you must negotiate with the Company, and revise the Separation Agreement accordingly. In addition, consider whether you want a letter of recommendation. If you want a letter of recommendation, the letter should be attached as an exhibit to the Separation Agreement. *** [Because I am not a tax attorney] [Because I am not familiar with your personal tax situation], [please consult your tax advisor for all tax-related issues arising out of or related to the Separation Agreement and your Company employment.] Please feel free to call me at any time if you have any questions or concerns or would like to further discuss any of the issues raised in this letter. Sincerely,

Example of a Separation Agreement and Release

Following is a generic separation and release agreement. Employer-provided draft separation agreements may have additional (and more onerous) terms included. In the unlikely event the executive is asked to provide the first draft of the separation agreement, the separation agreement below may be modified to make it more pro-executive. ***


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SEPARATION AGREEMENT AND RELEASE41 This Separation Agreement and Release (“Agreement”) is entered into by ______________ (“Executive”) and _______________ (“Employer”). Executive and Employer are individually referred to in this Agreement as “Party” and collectively referred to in this Agreement as the “Parties.” RECITALS WHEREAS, Executive was employed by the [ ___________________ ], dated [ ______________ ];

Employer

pursuant

to

WHEREAS, on [ ______ ], the Employer and Executive entered into an indemnification agreement (“Indemnification Agreement”), which is attached as Exhibit 1; WHEREAS, on [ ______ ], the Employer and Executive entered into a confidential information and invention assignment agreement (“CIIAA”), which is attached as Exhibit 2; WHEREAS, on [ ______ ], the Employer granted Executive a stock option (“Option”) to purchase shares of the Employer’s common stock subject to the terms and conditions of the Employer’s 2011 Equity Incentive Plan, the notice of stock option grant signed by Executive, and the stock option agreement signed by Executive (collectively referred to in this Agreement as, the “Stock Option Contract”). The Stock Option Contract is attached as Exhibit 3; WHEREAS, the Parties desire to resolve all claims, complaints, grievances, charges, actions, and demands that Executive may have against the Employer and any of the Employer-related persons or entities listed below;

*** NOW, THEREFORE, in consideration of the mutual promises and consideration set forth in this Agreement, the sufficiency of which is hereby acknowledged, the Employer and Executive agree as follows: 1. Termination of Employment. Executive’s employment terminate[s][d] on _______________________ (“Separation Date”).

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The author retains the copyright to this example document.

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2. Separation Payment. The Employer shall pay Executive, in one lump sum payment, the amount of __________________ dollars ($____________ ), less legally required withholding (“Separation Payment”). The Separation Payment shall be delivered to Executive on or before the third business day after the Effective Date. 3. Payment in Lieu of Outplacement. In addition to the Separation Payment, the Employer shall pay Executive _____________ dollars ($____________) in lieu of paid outplacement services (“Outplacement Payment”). The Outplacement Payment shall be made on or before the third business day after the Effective Date. 4. COBRA Reimbursement. In addition to the Separation Payment and Outplacement Payment, the Employer shall reimburse Executive for [ ______ ] months of COBRA premium payments (“COBRA Reimbursement”), providing Executive timely elects COBRA coverage and no other third party reimburses Executive for the COBRA premium payments reimbursed under this section. 5. Stock Options. The vesting of [ ___________ ] shares of stock subject to the Option shall be accelerated so that these shares are fully vested and completely exercisable as of the Separation Date. As of the Separation Date, the Executive [shall be] [has] fully vested in ____________ shares subject to the Option. The last day for Executive to exercise his fully vested options shall be [ __________________ ]. Executive’s Stock Option Contract shall survive this Agreement. 6. Property Retention. Executive shall retain, and at all times on and after the Effective Date exclusively own, his Employer provided [ _______________ ]. The value of this property is [ ___________ ]. 7. Expenses Reimbursement. Executive has submitted [$______________ ] (“Reimbursement Amount”) in receipts for expenses reimbursable under the Company’s expense reimbursement plan. The Reimbursement Amount shall be paid to Executive on or before the third business day after the Effective Date. 8. Attorneys’ Fees Reimbursed. The Company shall reimburse Executive for the reasonable attorneys’ fees Executive incurs in connection with the negotiation and review of this and other separation-related agreements. The Executive shall provide proof of the attorneys’ fees he incurred within 15 calendar days of the Effective Date. The Company shall reimburse Executive for the attorneys’ fees he incurred on or before the thirtieth calendar day after the Effective Date. 9. Payment of Salary and Other Benefits. Except as set forth in this Agreement, Executive represents that the Employer has paid all salary, wages, bonuses, severance, outplacement costs, reimbursable expenses, commissions and [ _________ ] and provided all stock, stock options, vesting, [ _________ ] and any and all other benefits and compensation due to Executive. Employer agrees that it will not in any way oppose or object to Executive’s application for unemployment insurance benefits or Executive’s right to collect unemployment insurance benefits.


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10. Surviving Agreements. The Indemnification Agreement and the CIIAA shall remain in full force and effect notwithstanding any other term in this Agreement. 11. Release of Claims. Executive, on behalf of himself and on behalf of his heirs, executors, and assigns, forever releases the Employer and its current and former officers, directors, employees, agents, investors, attorneys, shareholders, administrators, affiliates, divisions, and subsidiaries, and predecessor and successor corporations and assigns (collectively, the “Releasees”) from any claim, complaint, charge, duty, obligation, demand, count or cause of action relating to any matters of any kind, whether presently known or unknown, suspected or unsuspected, that Executive may possess against any of the Releasees arising from any omissions, acts, facts, or damages that have occurred from the beginning of time up to and including the Effective Date of this Agreement. Notwithstanding any other term in this Agreement, this release does not release (i) any obligations arising out of this Agreement, (ii) [ ____________ ]. 12. Waiver of Claims under ADEA. Executive acknowledges that he is waiving and releasing any rights he may have under the Age Discrimination in Employment Act of 1967 (“ADEA”). Executive agrees that this waiver and release is knowing and voluntary. The parties agree that this waiver and release does not apply to any rights or claims that may arise under the ADEA after the Effective Date of this Agreement. Executive acknowledges that the consideration given for this waiver and release is in addition to anything of value to which Executive was already entitled. Executive further acknowledges that he has been advised by this writing that: (i) he should consult with an attorney prior to executing this Agreement; (ii) he has twenty-one (21) days to consider this Agreement; (iii) he has seven (7) days following his execution of this Agreement to revoke this Agreement; (iv) this Agreement shall not be effective until after the revocation period has expired; and (v) nothing in this Agreement prevents Executive from challenging or seeking a determination in good faith of the validity of this waiver under the ADEA, nor does it impose any condition precedent, penalties, or costs for doing so, unless specifically authorized by federal law. In the event Executive signs this Agreement and returns it to the Employer in less than the 21-day period identified above, Executive acknowledges that he has freely and voluntarily chosen to waive the time period allotted for considering this Agreement. The effective date (“Effective Date”) of this Agreement shall be the eighth day after Executive signs this Agreement, providing that Executive has not revoked the Agreement as permitted by this section. Revocation must be accomplished by a written notification to [ _____________ ] prior to the Effective Date. [13. California Civil Code § 1542. Executive is familiar with California Civil Code § 1542 (“§ 1542”) which provides as follows: A General Release Does Not Extend To Claims Which The Creditor Does Not Know Or Suspect To Exist In His Or Her Favor At The Time Of Executing The Release,

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Executive Employment Law Which If Known By Him Or Her Must Have Materially Affected His Or Her Settlement With The Debtor.

Executive waives any rights he may have under § 1542, as well as under any other similar state or federal statute or common law principle.] 14. No Pending Lawsuits. Each Party represents that he or it has no pending lawsuits, claims, or actions pending against the other Party. Executive represents that he has no pending lawsuits, claims, or actions against Releasees. The Company represents that it has no present intention of suing Executive. 15. Confidentiality. Executive shall not disclose the existence or terms of this Agreement, except that Executive may disclose the information to his immediate family members, attorneys, tax advisers, financial advisors, banks or financial institutions, or to any government agency which requests a copy of this Agreement, or as otherwise required by law. 16. Non-disparagement. Executive and Employer shall not disparage each other [nor, _____________________ ]. 17. Non-solicitation. Executive agrees that for a period of [ ____ ] months following the Effective Date of this Agreement, Executive shall not solicit any of the Employer’s employees to leave their employment with the Employer. 18. Third Party Inquiries. All third party inquiries to Employer regarding executive shall be directed to [ _______________ ] who shall say only [ ______________ ]. 19. No Admission of Liability. No action taken by the Employer in connection with this Agreement shall be construed to be an admission by the Employer of any fault or liability to Executive or to any third party. 20. Severability. In the event that any clause or any part of a clause is declared by a court or arbitrator to be illegal, unenforceable, or void, the court or arbitrator shall revise the clause or part of a clause in a way that best conforms to the original intent of the parties, providing that the Agreement shall continue in full force and effect regardless of whether or not the provision at issue is revised. 21. Amendment. This Agreement may only be amended in a writing signed by Executive and the Employer’s Chief Executive Officer. 22. Waiver. This Agreement may not be waived, except by an agreement in writing signed by Executive and the Company. The waiver of any term of this Agreement does not constitute a waiver of the same term at a later time, nor a waiver of any other term in this Agreement. 23. Governing Law and Venue. This Agreement shall be governed by the laws of the State of [ __________ ], without regard to [ ____________ ] choice of law rules.


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The exclusive jurisdiction and venue for all disputes arising out of or relating to this Agreement and/or Executive’s employment with the Company shall be [ ____________ ]. 24. No Duty to Mitigate. Executive shall have no duty to mitigate any breach by the Employer of this Agreement. 25. Headings. The headings in this Agreement are for convenience only and shall not affect the meaning or interpretation of any term of this Agreement. 26. Notices. All notices and communications that are required or permitted to be given under this Agreement shall be in writing and shall be deemed given when delivered personally or one business day after sending, if sent by a national overnight express delivery service for next-day service. Delivery shall be made to the addresses set forth in this Agreement, or to any other address specified in a notice given by one Party to the other Party pursuant to this section. 27. Representation by Counsel. The Parties represent that they have been represented by counsel in the preparation and negotiation of this Agreement, and have carefully read and understand the scope and effect of this Agreement. Neither Party has relied on any representations or statements made by the other Party which are not specifically set forth in this Agreement. 28. Entire Agreement. This Agreement, the CIIAA, the Stock Option Contract and the Indemnification Agreement, and all contracts referenced in these agreements, represent the entire agreement and understanding between the Employer and Executive concerning the subject matter of this Agreement and supersede and replace all prior agreements and understandings concerning the subject matter of this Agreement. 29. Signing & Counterparts. This Agreement may be executed by facsimile signature or by signing, scanning and e-mailing, and in counterparts, each of which shall be deemed an original agreement, and all of which taken together shall be one instrument. IN WITNESS WHEREOF, the Parties execute this Agreement on the dates set forth below.

10 T H E EX E C UT I VE ’ S ABIL ITY TO COM PE TE AG A I N S T H I S F O R M E R EM PLOYE R — A BRIE F OVE RV I E W

§ 10.1 Non-Compete Agreements

If your executive client has signed, or will sign, a non-compete agreement, it is imperative that you understand the laws on restrictive covenants of all applicable jurisdictions. Contractual non-compete agreements (and non-compete clauses) are widely used by American employers, except in California. Non-compete agreements typically prohibit an employee who has left an employer from competing, either directly or indirectly, against the employer—or a part of the employer’s business—for some period of time in a geographic area. Many non-compete agreements also limit the employee’s ability to invest in or otherwise indirectly aid competitive entities. Non-compete clauses and agreements vary widely in scope. A non-compete agreement’s prohibition against competition may be limited to a short list of competitors or, on the other hand, may extend to any entity that competes with the employer’s anticipated business. Restrictive time periods for non-compete obligations range from months to years. Geographic limitations may be as small as a locality and as large as the entire world. The enforceability of non-compete agreements depends on the state law governing the employment relationship. For example, under Texas law, a covenant not to compete is enforceable . . . to the extent that it contains limitations as to time, geographical area, and scope of activity to be restrained 226

The Executive’s Ability to Compete Against His Former Employer

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that are reasonable and do not impose a greater restraint than is necessary to protect the goodwill or other business interest of the [employer].1 States vary in their tolerance of non-compete agreements and their willingness to enforce the agreements. Where to draw the line between the employer’s right to continue doing business unimpeded by an ex-employee and the ex-employee’s right to earn a livelihood differs by jurisdiction.2 Illinois courts, for example, are reluctant to enforce non-compete agreements.3 “Postemployment restrictive covenants operate as partial restrictions on trade, so they are scrutinized carefully” by Illinois courts.4 By contrast, “public policy in Florida favors enforcement of reasonable covenants not to compete.”5 “Where . . . employment is terminable at will by either the employer or employee, Florida courts have routinely enforced non-compete agreements . . . .”6 Both Illinois and Florida courts state that they will enforce “reasonable” restrictive covenants. However, they differ on what they consider “reasonable.” In Illinois, [a] restrictive covenant is enforceable if the terms of the agreement are reasonable and necessary to protect a legitimate business interest of the employer, a determination that necessarily turns on the facts and circumstances of each case. A restrictive covenant’s reasonableness is measured by its hardship to the employee, its effect upon the general public, and the reasonableness of the time, territory, and activity restrictions.7 By contrast, Florida employers may enforce non-compete agreements “so long as such contracts are reasonable in time, area, and line of business,” and the employer can

1

Tex. Bus. & Com. Code Ann. § 15.50(a); see also Alex Sheshunoff Mgmt. Serv., L.P. v. Johnson, 209 S.W.3d 644, 654 (Tex. 2006). 2 Compare Hilligoss v. Cargill, Inc., 649 N.W.2d 142, 147 n. 8 (Minn. 2002) (“Blue-pencil doctrine” allows a Minnesota court “at its discretion to modify unreasonable restrictions on competition in employment agreements by enforcing them to the extent reasonable”), with L&B Transport, LLC v. Beech, 568 F. Supp. 2d 689, 697–98 (M.D. La. 2008) (court refuses to revise non-compete provision despite contract’s severability clause). 3 See Del Monte Fresh Produce, N.A., Inc. v. Chiquita Brands International, Inc., 616 F.Supp.2d 805, 816–17 (N.D. Ill. 2009). 4 Cambridge Eng’g, Inc. v. Mercury Partners 90 BI, Inc., 879 N.E.2d 512, 522 (Ill. App. Ct. 2007); see Zimmer, Inc. v. Sharpe, 651 F.Supp.2d 840, 843 (N.D. Ind. 2009) (“Indiana and Louisiana law both generally disfavor non-competition provisions and strictly construe such provisions against the employer”). 5 Autonation, Inc. v. O’Brien, 347 F.Supp.2d 1299, 1308 (S.D. Fla. 2004). 6 Open Magnetic Imaging, Inc. v. Nieves-Garcia, 826 So.2d 415, 417 (Fla. Dist. Ct. App. 2002). 7 Lawrence & Allen, Inc. v. Cambridge Human Resource Group, Inc., 685 N.E.2d 434, 441 (Ill. App. Ct. 1997) (internal citations omitted).

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show “the existence of one or more legitimate business interests justifying the restrictive covenant.”8

§ 10.2 Paying for the Non-Compete Agreement

Some jurisdictions that might otherwise hesitate to enforce a non-compete agreement will do so when the non-compete agreement requires the employer to continue to pay the employee his salary during the term of the agreement, and the employer continues to pay post-employment. One New York court determined: [T]he restrictive covenants at issue . . . are reasonable on condition that [employees] continue to receive their salaries for six months while not employed by a competitor. The restrictive covenants are reasonable in that each protects the employer from severe economic injury while—at the same time—it protects the employee’s livelihood, by requiring that he be paid his base salary.9

§ 10.3 Compete and Forfeit Agreements: Employee Choice Doctrine

“Compete and forfeit” clauses or agreements do not prohibit, although they may discourage, former employees from competing against their former employers. These contracts provide that former employees joining competitors forfeit benefits to be paid or provided by their ex-employers after the onset of competition.10 Sometimes the contracts also contain a clawback clause requiring ex-employees who compete in violation of the non-compete clause to repay (or forfeit) benefits previously received from the employer.11

8

Fla. Stat. § 542.335(1). Other jurisdictions may use additional or different factors, including considering whether the employee is an executive, in assessing the “reasonableness” of a non-compete agreement. See e.g., Thiesing v. Dentsply Intern’l, Inc. __ F.Supp.2d __, 2010 WL 3835136, at *17 (E.D. Wis. 2010) (“The free movement and personal liberty of employees . . . must be balanced against the right of the employer to protect himself from unfair competition . . . .[W]hen it comes to business executives and professional employees, the interest to be protected is more substantial . . . .”) (internal quotation and citation omitted). 9 Maltby v. Harlow Meyer Savage, Inc., 633 N.Y.S.2d 926, 930 (N.Y. Sup. Ct. 1995); see also Campbell Soup Co. v. Desatnick, 58 F.Supp.2d 477, 482 (D.N.J. 1999) (enforcing non-compete agreement where contract “provides a safety net” to employee unable to find employment with a non-competitor by requiring employer to pay 100 percent of monthly salary and benefits beginning 90 days after employment termination date and continuing for 18 months of the non-compete obligation or until employee finds another suitable position); MTV Networks v. Fox Kids Worldwide, Inc., No. 605580/97, 1998 WL 57480, at *9 (N.Y. Sup. Ct. Feb. 4, 1998) (enforcing non-compete agreement where new employer agreed to pay base salary and bonus if non-compete enforced against employee). 10 See cases cited in footnote 15. 11 See, e.g., Johnson v. MPR Associates, Inc., 894 F.Supp. 255 (E.D. Va. 1994) (employees competing against ex-employer required to return stock to ex-employer where stock purchase agreement contained


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Courts in some states may enforce agreements that require the former employee to forfeit benefits when he competes with his ex-employer where the court would not enforce a traditional non-compete agreement to prohibit the competitive conduct.12 Courts enforcing compete and forfeit clauses sometimes do so under the so-called “employee choice doctrine.” This doctrine emphasizes the distinction between an outright prohibition on competition and a financial penalty for competing and provides that employee benefits are forfeitable because the departing employee has a choice: compete and forfeit benefits, or refrain from competing and receive benefits.13 The willingness of certain states to enforce compete and forfeit clauses depends on the circumstances underlying the termination of employment. New York courts, for example, will enforce compete and forfeit clauses only against employees whose employment is involuntarily terminated for cause or who voluntarily quit their employment but not against employees whose employment is involuntarily terminated without cause.14

non-compete clause requiring return of stock if employees competed within three years of termination of employment); Viad Corp. v. Houghton, 2010 WL 748089 (N.D. Ill. 2010) (executive required to repay ex-employer $102,000 received under a management incentive plan because executive breached twoyear non-compete clause in the plan); GES Exposition Services, Inc. v. Floreano, 2007 WL 4323012 (D. Mass. 2007) (employee required to repay ex-employer $85,100 bonus where employee quit and began working for competitor in violation of non-compete clause in bonus plan). 12 See, e.g., Dobbins, DeGuire & Tucker, P.C. v. Rutherford, MacDonald & Olson, 218 Mont. 392, 395–96 (1985) (temporary compete and forfeit provision is reasonable where an outright prohibition would not be); Stipp v. Wallace Plating, Inc., 523 P.2d 822, 824 (Idaho 1974) (pension forfeiture covenant “involves only the loss of the amount of the employer’s contribution to the pension plan,” and thus “the reasonableness of the plan is not subject to the same high degree of scrutiny as covenants found in employment contracts”); Van Pelt v. Berefco, Inc., 208 N.E.2d 858, 865 (Ill. App. Ct. 1965) (“There is no restraint here upon plaintiff ’s right to future employment. He is free to engage in competition . . . without restraint or interference by defendants, but he is not free to do so while accepting benefits of the retirement plan to which he contributed nothing”). 13 See, e.g., Tatom v. Ameritech Corp., 305 F.3d 737, 744 (7th Cir. 2002) (affirming forfeiture of vested stock options where employee works for a competitor; “This is not a case that involves a facially anti-competitive provision; nothing in the agreements at issue actually restricted [employee’s] ability to work for [employer’s] competitors. Federal cases draw a distinction between provisions that prevent an employee from working for a competitor and those that call for a forfeiture of certain benefits should he do so”); Miller v. Assoc. Pension Trusts, Inc., 396 F. Supp. 907, 911 (D.C. Mo. 1975) (“The effect of the plan’s provision is not that of a restrictive covenant which would bar the employee from earning a living but rather provides him with a choice as to whether he wishes to compete with his former employer at the expense of losing his accrued benefits”); Rochester Corp. v. Rochester, 450 F.2d 118, 123 (4th Cir. 1971) (“forfeiture [under a compete and forfeit clause], unlike the restraint included in the employment contract, is not a prohibition on the employee’s engaging in competitive work but is merely a denial of his right to participate in the retirement plan if he does so engage”); see also Mayer Hoffman McCann, P.C. v. Barton, 614 F.3d 893 (8th Cir. 2010) (affirming $1.369 million liquidated damages clause under Missouri law against four shareholder employees of former accounting firm who breached contractual non-compete agreement with the firm). Note that federal law prohibits forfeiture of vested benefits in certain classes of pension plans governed by ERISA. 29 U.S.C. § 1053. 14 Compare Krisst v. Whelan, 4 A.D.2d 195, 199 (N.Y. Sup. Ct. 1957) aff ’d w/o op. 155 N.E.2d 116 (N.Y. 1958) (“It is no unreasonable restriction on the liberty of a man to earn a living if he may be relieved of the restriction by forfeiting a contract right or by adhering to the provisions of his contract”); with Post v.

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There are also those states that invalidate compete and forfeit clauses that cause forfeitures for competitive activities broader than those that could legally be prohibited by a non-compete clause. For example, a Georgia court ruled that “a forfeiture provision that is conditioned expressly upon an invalid covenant must be invalid in se.”15 Similarly, California courts will void an employment agreement premising the forfeiture of employee benefits on a former employee competing in later employment as akin to an unenforceable non-compete clause.16

§ 10.4 Prohibitions on the Use of a Former Employer’s Trade Secrets and Proprietary Information Even When No Confidentiality Agreement Exists

Most employers require their employees to enter into CIIAAs as a condition of employment. CIIAAs are discussed in § 4.5 and § 7.6. CIIAAs and non-compete agreements do not delimit the employee’s potential liability for misappropriating an ex-employer’s trade secrets. An employee cannot compete against his former employer with the ex-employer’s trade secrets or proprietary information without the employer’s permission, whether or not the employee is bound by a non-compete or confidentiality agreement with the former

Merrill Lynch, Pierce, Fenner & Smith, Inc., 397 N.E.2d 358, 361 (N.Y. 1979) (“where an employee is involuntarily discharged by his employer without cause and thereafter enters into competition with his former employer . . . a forfeiture is unreasonable as a matter of law”); see Morris v. Schroeder Capital Management International, 481 F.3d 86, 88–89 (2d Cir. 2007) (upholding employee choice doctrine where employee voluntarily terminated employment); Lucent v. International Business Machines Corp., 310 F.3d 243, 254–55 (2d Cir. 2002) (New York employer can rely on employee choice doctrine only if it can demonstrate its continued willingness to employ the party who covenanted not to compete; employer cannot rely on doctrine when employee is involuntarily discharged without cause). 15 A.L. Williams & Assoc. v. Faircloth, 386 S.E.2d 151, 153 (Ga. 1989). Other states have reached a similar result. See, e.g., Cheney v. Automatic Sprinkler Corp. of America, 377 Mass. 141 (1979) (requiring that compete and forfeit covenants operate according to the same reasonableness rules as covenants not to compete, despite previous cases to the contrary); Food Fair Stores, Inc. v. Greeley, 285 A.2d 632, 640 (Md. 1972) (pension forfeiture clause “constituted an invalid restraint upon [the plaintiff ’s] right to earn a livelihood”); Snarr v. Picker Corp., 504 N.E.2d 1168, 1171 (Oh. Ct. App. 1985) (refusing to enforce forfeiture of pension benefits where no actual competitive harm was caused by violation of the non-compete clause); Graham v. Hudgins, Thompson, Ball & Associates, Inc., 540 P.2d 1161, 1165 (Okla. 1975) (finding little difference between a traditionally unenforceable non-compete clause and a pension forfeiture agreement); Lacey v. Edwards, 505 P.2d 342 (Or. 1973) (compete and forfeit provision subject to the same reasonable bounds as a non-compete agreement); Almers v. South Carolina National Bank of Charleston, 217 S.E.2d 135 (S.C. 1975) (denying compete and forfeit clause for pension benefits where non-compete clause would not be allowed). 16 See, e.g., Edwards v. Arthur Andersen, LLP, 189 P.3d 285, 292 (Cal. 2008) (“if the Legislature intended the statute [prohibiting non-compete agreements in employment] to apply only to restraints that were unreasonable or overbroad, it could have included language to that effect”); Muggill v. Reuben H. Donnelley Corp., 398 P.2d 147, 149 (Cal. 1965) (“the provision forfeiting plaintiff ’s pension rights if he works for a competitor restrains him from engaging in a lawful business and is therefore void”). See also Brian M. Malsberger, Covenants Not To Compete: A State-By-State Survey (6th ed. 2008 & Supp. BNA 2009) for a state-by-state analysis of the enforceability of non-compete agreements.


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employer. State and federal statutes, as well as case law, protect an employer’s trade secrets and electronic data from misappropriation, including misappropriation undertaken for the purpose of competing against the employer. § .. civil liability and equitable relief Many employers aggressively protect their proprietary information and trade secrets and will seek court intervention if they believe an ex-employee has misappropriated (or is likely to misappropriate) critical company information. Federal and state courts will not hesitate to enjoin an ex-employee in circumstances of trade secret misappropriation.17 The employee may be held civilly liable in most states for misappropriating an employer’s trade secrets. The Uniform Trade Secrets Act (UTSA) provides for injunctions, civil liability, and attorneys’ fee shifting in cases of threatened or actual trade secret misappropriation.18 The UTSA has been passed in one form or another in most states and the District of Columbia.19 In California, in certain circumstances, officers and directors who are also investors in their companies may be personally liable for their companies’ trade secret misappropriation.20 At the federal level, the Computer Fraud and Abuse Act (CFAA) provides for injunctive relief and monetary damages for those injured by others absconding with trade secrets from computers used in interstate commerce.21 Courts have used the CFAA to enjoin ex-employees and their new employers from competing using data taken from the former employer.22

17

See, e.g., Winston Research Corp. v. Minnesota Min. & Mfg. Co., 350 F.2d 134, 142 (9th Cir. 1965) (approving a two-year injunction for trade secret misappropriation by an employee); General Elec. Co. v. Sung, 843 F. Supp. 776, 780 (D. Mass 1994) (the “production of saw grade diamond was inextricably connected to the technology found by the jury to be GE trade secrets and . . . [the] saw grade diamond process was entirely dependent upon that misappropriated technology. Under these circumstances, a production injunction is warranted”); American Bldgs. Co. v. Pascoe Bldg. Systems, Inc., 392 S.E.2d 860, 864 (Ga. 1990) (“When one has acquired a trade secret by reason of a confidential business relationship with the holder of the trade secret, an injunction restraining the divulgence of the trade secret will lie”); Space Aero Products Co. v. R. E. Darling Co., 208 A.2d 74, 89 (Md. 1965) (“Injunction is a proper equitable remedy to protect the interest of the proprietor of a trade secret against the wrongful use of that secret . . . .”); Felmlee v. Lockett, 351 A.2d 273, 277–78 (Pa. 1976) (“We believe with respect to appellees’ chemical formula for soft plastic that this is clearly a proper case to afford appellees equitable relief”). 18 Uniform Trade Secrets Act, 14 U.L.A. 529. 19 See, e.g., Cal. Civ. Code § 3426.1–11; D.C. Code § 36–401, et seq.; Del. Code Ann. tit. 6, §§ 2001–09; Fla. Stat. § 688.001–09; 765 Ill. Comp. Stat. 1065/1–9. A list of states that have adopted the UTSA can be found online. See Cornell Legal Information Institute, Uniform Business and Financial Laws Locator, www.law.cornell.edu/uniform/vol7.html#trdsec (last visited May 12, 2010). 20 PMC, Inc. v. Kadisha, 93 Cal.Rptr.2d 663, 677 (Ca. Ct. App. 2000). 21 18 U.S.C. § 1030(g). 22 See, e.g., YourNetDating, Inc. v. Mitchell, 88 F.Supp.2d 870, 872 (N.D. Ill. 2000) (granting TRO for employer pursuant to CFAA against ex-employee).

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§ .. the inevitable disclosure doctrine The “inevitable disclosure” doctrine provides that a sufficiently senior executive, or a sufficiently well-placed employee, cannot purge himself of, nor forget, the critical confidential information and trade secrets of his ex-employer and therefore will inevitably misappropriate (disclose) the former employer’s trade secrets and confidential information if he directly competes with the former employer.23 The “inevitable disclosure doctrine” is judicially created and exists in addition to statutory and contractual prohibitions against competition. Courts vary in their willingness to invoke the doctrine.24 Courts in jurisdictions that recognize the inevitable disclosure doctrine will enjoin employees from working for competitors of their former employers where the court determines the employee will “inevitably disclose” the former employer’s trade secrets. Invoking the inevitable disclosure doctrine, a court might, for example, enjoin the former vice president of engineering of a security software company from working as the chief technology officer of that company’s major competitor because the new CTO must “inevitably disclose” or “inevitably use” his former employer’s trade secrets and confidential information in his new job. § .. criminal liability Misappropriating a former employer’s trade secrets may violate both state and federal criminal laws, depending on the state, the intellectual property misappropriated, and the manner in which the property was misappropriated. The federal Economic Espionage Act of 1996 (EEA)25 and CFAA26 contain harsh criminal penalties and may be

23

See, e.g., PepsiCo, Inc. v. Redmond, 54 F.3d 1262, 1269–70 (7th Cir. 1995); Merck & Co., Inc. v. Lyon, 941 F. Supp. 1443, 1457–58 (M.D.N.C. 1996). 24 Compare PepsiCo, Inc. v. Redmond, 54 F.3d 1262, 1269 (7th Cir.1995) (“a plaintiff may prove a claim of trade secret misappropriation by demonstrating that defendant’s new employment will inevitably lead him to rely on the plaintiff ’s trade secrets”), Allis-Chalmers Mfg. Co. v. Continental Aviation & Engineering Corp., 255 F. Supp. 645, 654 (E.D. Mich. 1966) (finding “an inevitable and imminent danger of disclosure” by departing employee moving to competing corporation), E. I. duPont de Nemours & Co. v. Am. Potash & Chem. Corp., 200 A.2d 428, 436 (Del. Ch. 1964) (“the court is entitled to consider, in judging whether an abuse of confidence is involved, the degree to which disclosure of plaintiff ’s trade secrets is likely to result from” previous employment), and Strata Marketing, Inc. v. Murphy, 740 N.E.2d 1166, 1178 (Ill. App. Ct. 2000) (adopting the PepsiCo view that “inevitable disclosure is a theory upon which a plaintiff in Illinois can proceed under the [Illinois Trade Secrets Act]”), with FLIR Systems, Inc. v. Parrish, 95 Cal.Rptr.3d 307, 314 (Cal. Ct. App. 2009) (“The doctrine of inevitable disclosure is not the law in California”); LeJeune v. Coin Acceptors, Inc., 849 A.2d 451, 471 (Md. 2004) (rejecting the inevitable disclosure doctrine), Marietta Corp. v. Fairhurst, 754 N.Y.S.2d 62, 65–66 (N.Y. App. Div. 2003) (“the doctrine of inevitable disclosure is disfavored . . . ‘[a]bsent evidence of actual misappropriation by an employee’” (quoting EarthWeb, Inc. v. Schlack, 71 F.Supp.2d 299, 310 (S.D.N.Y. 1999)), and Hydrofarm, Inc. v. Orendorff, 905 N.E.2d 658, 665 (Ohio Ct. App. 2008) (refusing to apply the inevitable disclosure doctrine without a non-compete agreement or showing of “a serious threat to his former employer’s business or a specific segment thereof”). 25 18 U.S.C. §§ 1831–39. 26 18 U.S.C. § 1030.


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used by the government against wayward employees in certain circumstances. The EEA criminalizes the theft of trade secrets for the benefit of (i) anyone other than the owner or (ii) a foreign government.27 Individuals found guilty of domestic violations of the EEA face fines up to $250,000 and ten years in prison.28 The CFAA protects computers used in interstate commerce and by financial institutions and the United States against unauthorized access or access that exceeds one’s authority.29 Punishment for domestic violations of the CFAA may include prison terms of up to ten years.30

§ 10.5 California: Non-Compete Agreements Are Unenforceable Except in Limited Circumstances

§ .. california state courts California Business and Professions Code § 16600 provides that non-compete agreements are enforceable in California only in the following limited circumstances: • To restrain “[a]ny person who sells the goodwill of a business.”31 • To restrain “any owner of a business entity selling or otherwise disposing of all of his or her ownership interest in the business entity.”32 • To restrain “any owner of a business entity that sells (a) all or substantially all of its operating assets together with the goodwill of the business entity, (b) all or substantially all of the operating assets of a division or a subsidiary of the

27

18 U.S.C. §§ 1831, 1832. 18 U.S.C. §§ 1831(a), 1832(a), 3571(b). 29 18 U.S.C. § 1030(e)(2). 30 18 U.S.C. § 1030(c)(3)(B). 31 Cal. Bus. & Prof. Code § 16601. Cal. Bus. & Prof. Code § 16600 provides, “Except as provided in this chapter, every contract by which anyone is retrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” Cal. Bus. & Prof. Code §§ 16601, 16602, and 16602.5 describe the circumstances in which California permits non-compete agreements. 32 Cal. Bus. & Prof. Code § 16601. In a case involving the scope of this clause, the California Court of Appeal determined: 28

Literally applied, section 16601 would permit a major public corporation to require any employee to purchase one of several million shares and to enter into an agreement not to work for a competitor—an absurd result, and contrary to the state’s public policy prohibiting such agreements . . . . [A] literal interpretation of § 16601 leads to a mischievous and absurd result. *** § 16601 permit[s] non-competition agreements only in situations in which the transfer of ‘all’ of the owner’s shares involves a substantial interest in the corporation so that the owner, in transferring ‘all’ of his shares, can be said to transfer the goodwill of the corporation. Bosley Medical Group v. Abramson, 207 Cal.Rptr. 477, 481–82 (Cal. Ct. App. 1984).

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business entity together with the goodwill of that division or subsidiary, or (c) all of the ownership interest of any subsidiary . . . .”33 • To restrain a partner leaving a partnership.34 • To restrain a member leaving a limited liability company.35 Consequently, California founders cannot start a company, sell their company, and then open up a competing enterprise the following day (unless the acquirer fails to require the founder to enter into a non-compete agreement). Non-compete agreements are a regular part of California buy-sell and M&A transactions. California’s statutes specifically permit, and California courts will enforce, transaction-based non-compete agreements against “substantial” selling shareholders for qualifying transactions.36 Non-compete agreements are also frequently used in California to restrain management team members who sell their companies (or merge them into larger entities) and are, at the same time, “substantial” selling shareholders. Although the threshold between substantial and non-substantial selling shareholder is unclear, one California court determined that a 3 percent shareholder who was also the company’s ninth largest shareholder qualified as a substantial selling shareholder.37 Employment-based non-compete agreements, as distinct from transaction-based agreements, however, are unenforceable in California. Moreover, California does not recognize the “inevitable disclosure” doctrine.38 California courts require proof of an actual threat of misappropriation before they will issue an injunction prohibiting competition in employment based on illicit disclosure of confidential information.39 California courts have also eliminated the “non-solicitation of customers” approach to avoiding California’s proscription against non-compete agreements. Previously, some California employers inserted a clause in their employment agreements prohibiting the employee from soliciting the employer’s customers for a period of time after the termination of an employee’s employment. California’s Court of Appeal

33

Cal. Bus. & Prof. Code § 16601. Cal. Bus. & Prof. Code §§ 16601, 16602. 35 Cal. Bus. & Prof. Code §§ 16601, 16602.5. 36 Cal. Bus. & Prof. Code § 16601; Vacco Industries, Inc. v. Van Den Berg, 6 Cal.Rptr.2d 602, 609–10 (Cal. Ct. App. 1992). 37 Vacco Industries, 6 Cal.Rptr.2d at 609–10. 38 FLIR Systems, Inc. v. Parrish, 95 Cal.Rptr.3d 307, 314 (Cal. Ct. App. 2009). See explanation and cases cited in FLIR Systems, 95 Cal.Rptr.3d at 314 n.3. The “inevitable disclosure” doctrine is discussed in § 10.4.2. 39 Globespan, Inc. v. O’Neill, 151 F.Supp.2d 1229, 1235 (C.D. Cal. 2001) (“To find misappropriation, California courts require that the trade secret be used by the Defendant or disclosed by the Defendant to a third party”); Bayer Corp. v. Roche Molecular Systems, Inc., 72 F.Supp.2d 1111, 1120 (N.D. Cal. 1999) (“A tradesecrets plaintiff must show an actual use or an actual threat”); FLIR Systems, 95 Cal.Rptr.3d at 314 (The doctrine of inevitable disclosure is not the law in California). 34


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ruled that a prohibition against soliciting an ex-employer’s customers constitutes an unenforceable non-compete agreement.40 California will not enforce laws, such as laws favoring enforcement of non-compete agreements, contrary to its “fundamental polic[ies].”41 In litigation involving the enforceability of non-compete clauses, California courts will generally disregard contractual forum selection clauses designating the law of a state favorable to noncompete agreements.42 In 2009, the California Supreme Court ruled that “[a]n employer ‘cannot lawfully make the signing of an employment agreement, which contains an unenforceable covenant not to compete, a condition of continued employment . . . . [A]n employer’s termination of an employee who refuses to sign such an agreement constitutes a wrongful termination in violation of public policy.’”43 Furthermore, an employer’s use of an illegal non-compete agreement with its employees constitutes unfair competition in California.44 Consequently, in most circumstances, California employees are free to compete against their former employers, providing they do not use the confidential or proprietary information of the former employer to compete against it. A California-based CEO is free to quit his position on any given day and go to work the next day as the CEO of his former employer’s biggest competitor. § .. the rise and fall of the ninth circuit’s narrow restraint exception Despite the hostility of California to non-compete agreements, in the 1980s, the Ninth Circuit Court of Appeals, which has jurisdiction over California, determined that “Section 16600 [of California’s Business and Professions Code] only makes illegal those restraints which preclude one from engaging in a lawful profession, trade, or business” and permitted “narrow restraints” on an employee’s ability to compete where those restraints did not preclude an employee from pursuing his entire profession.45 It

40

Dowell v. Biosense Webster, 102 Cal.Rptr.3d 1, 9 (Cal. Ct. App. 2009). Nedlloyd Lines B.V. v. Superior Court, 834 P.2d 1148, 1152 (Cal. 1992). 42 See, e.g., Application Group, Inc. v. Hunter Group, Inc., 72 Cal.Rptr.2d 73, 86 (Cal. Ct. App. 1998) (noncompete clause from Maryland employment contract, which included Maryland choice of law provision, unenforceable where consultant hired to work in California, because “California has a materially greater interest than does Maryland in the application of its law to the parties’ dispute”). 43 Edwards v. Arthur Andersen LLP, 189 P.3d 285, 294 (Cal. 2008) (quoting D’sa v. Playhut, Inc.,102 Cal. Rptr.2d 495, 497 (Cal. Ct. App. 2000)). 44 Dowell, 102 Cal.Rptr.3d at 8. 45 Campbell v. Board of Trustees of Leland Stanford Jr. University, 817 F.2d 499, 502 (9th Cir. 1987); see also Int’l Bus. Mach. Corp. v. Bajorek, 191 F.3d 1033 (9th Cir. 1999); General Commercial Packaging, Inc. v. TPS Package Eng’g, Inc., 126 F.3d 1131 (9th Cir. 1997). The five federal courts in California are the United States District Courts for the Northern, Southern, Eastern, and Central Districts of California; and the United States Court of Appeals for the Ninth Circuit. 41

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appeared that the Ninth Circuit simply did not approve of California’s public policy against non-compete agreements in employment, and in the absence of a directly on-point California “narrow restraint” decision, created its own law. A federal court in California enforcing California law would, in an appropriate situation, enforce a non-compete clause under the “narrow restraint” exception, even though a California state court would refuse to do so. In 2008, the California Supreme Court unequivocally ruled that there is no “narrow restraint” exception to § 16600 under California law.46 This decision ended the federal court’s “narrow restraint” exception because California courts are supreme on questions of California state law. Federal decisions handed down after the California Supreme Court’s ruling reflect this reality.47 § .. the executive who is subject to an out-of-state non-compete agreement moves to california § 10.5.3.1 Jurisdictional Issues Jurisdictional issues arise when an executive who signed a non-compete agreement while living and working outside California then moves there and goes to work for a California employer that competes against the executive’s former employer. In this circumstance, courts in the ex-employer’s home state will enforce the non-compete agreement against the executive, assuming the non-compete agreement is enforceable in the ex-employer’s home state. On the other hand, a California state court will not enforce a non-compete clause in an employment contract governed by another state’s law for an employee working in California, except in the limited circumstances discussed in § 10.5.1.48 § 10.5.3.2 The Race to the Courthouse Steps: California Public Policy vs. the Constitution’s Full Faith and Credit Clause

§ 10.5.3.2.1 The State Court Race The only way a California state court will enforce an out-of-state non-compete clause is if a sister state court enters a judgment enforcing the non-compete agreement against the now-California-based employee, and the out-of-state ex-employer seeks to enforce the judgment in California. The Full Faith and Credit Clause of the United States Constitution

46

Edwards, 189 P.3d at 293, 297. See In re Gault South Bay Litig., No. C 07–04659 JW, 2008 WL 4065843 at *4 (N.D.Cal. Aug. 27, 2008) (“Section 16600 may not be interpreted under a ‘rule of reasonableness’ or ‘narrow restraint’ standard; its prohibition is strict.”); Applied Materials, Inc. v. Advanced Micro-Fabrication Equip. (Shanghai) Co., 630 F.Supp.2d 1084, 1089 (N.D.Cal. 2009); Stuart v. Radioshack Corp., 259 F.R.D. 200, 202 (N.D. Cal. 2009). 48 See, e.g., Application Group, 72 Cal.Rptr.2d at 81. 47


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requires every state court to enforce every other state court’s judgments.49 Although California courts can choose not to enforce laws contrary to California’s public policy, they are required to enforce their sister state courts’ judgments even though a California would not enter a judgment if the underlying issue were before it.50 In other words, a California state court will not enforce a non-compete clause in an employment contract but will enforce a sister state court’s judgment enforcing the non-compete clause. The converse is also true. Non-California courts are required, under the Full Faith and Credit Clause, to enforce California state court judgments.51 Consequently, a California judgment declaring a contractual non-compete agreement invalid is enforceable in all other state courts, including the court in the state whose law, according to the non-compete agreement, governs the contract. When an out-of-state employee with an out-of-state non-compete clause moves to California to work for a new employer that competes with the ex-employer, the executive may void the non-compete clause by obtaining a judgment from a California court declaring the clause void and enjoining the ex-employer from enforcing it. After receiving the California court’s judgment, the executive may then have the judgment enforced by the ex-employer’s home state court against the ex-employer, thereby terminating the non-compete agreement. Hence, this situation may cause a race to the courthouse steps. If the ex-employer obtains a judgment in its home state court enforcing the non-compete clause before the now-California-based ex-employee obtains a judgment from a California court invalidating the non-compete clause, the ex-employer wins.52 It can enforce the out-ofstate judgment in California. However, if the now-California-based ex-employee obtains a judgment invalidating the non-compete first, then he wins. § 10.5.3.2.2 The Federal Court Race The result should be the same if the race to the courthouse takes place in the respective federal district courts for California and the ex-employer’s home state. Under the Erie doctrine, federal courts sitting in diversity apply the substantive law of the state in which they sit.53 The California federal court will apply California state law, and the federal district court for the ex-employer’s home state presumably will apply that state’s substantive law, including the applicable state’s conflict of laws rules.54 If the now-California-based ex-employee and ex-employer each file in the federal courts of their respective states, absent special circumstances, the federal district court

49

U.S. Const. art. IV, § 1 (“Full faith and credit shall be given in each State to the public Acts, Records, and judicial Proceedings of every other State”). 50 Baker v. General Motors Corp., 522 U.S. 222, 232–33 (1998); People v. Laino, 87 P.3d 27, 33 (Cal. 2004). 51 Baker, 522 U.S. at 232–33. 52 See, e.g., Great Frame Up Systems v. Jazayeri Enterprises, 789 F.Supp. 253 (N.D. Ill. 1992) (enforcing restrictive covenant against California company based on Illinois choice of law clause). 53 Erie R. Co. v. Tompkins, 304 U.S. 64, 78 (1938). 54 Klaxon Co. v. Stentor Elec. Mfg. Co., 313 U.S. 487 (1941).

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with the later-filed case should transfer the case to the federal district court with the earlier-filed case.55 If the case is transferred to California, the California federal district court will apply California’s substantive law, including its conflict of laws rules. If the case is transferred to the federal district court sitting in the ex-employer’s home state, the court should apply the ex-employer’s home state’s substantive law, including that state’s conflict of laws rules. California’s conflict of laws rules require that the court perform a “governmental interest analysis.”56 The analysis turns on “which jurisdiction has a greater interest in the application of its own law to the issue or, conversely, which jurisdiction’s interest would be more significantly impaired if its law were not applied.”57 Given California’s strong public policy against non-compete agreements, the conflict of laws analysis should default to the use of California law over the ex-employer’s home state’s law, even if the non-compete agreement contains a forum selection clause choosing the law of the ex-employer’s home state.58 Consequently, the federal district court sitting in California should refuse to enforce the ex-employer’s non-compete agreement. Presumably, the reverse will be true if the federal district court for the ex-employer’s home state hears the case.59 § 10.5.3.3 Protecting the Executive in Court Race Situations Not all ex-employers will enforce non-compete agreements against former employees. The cost to do so may be expensive, and at times, the result uncertain. Nevertheless, if your newly California-based executive client anticipates a non-compete-related dispute arising, he should consider requesting that the prospective California employer:

55

See, e.g., Coady v. Ashcraft & Gerel, 223 F.3d 1, 11 (1st Cir. 2000) (“Where identical actions are proceeding concurrently in two federal courts . . . the first filed action is generally preferred in a choice-of-venue decision”); First City Nat. Bank & Trust Co. v. Simmons, 878 F.2d 76, 79 (2d Cir. 1989) (“the first suit should have priority, absent the showing of balance and convenience . . . or . . . special circumstances . . . giving priority to the second”); Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Haydu, 675 F.2d 1169, 1174 (11th Cir. 1982) (“in the absence of compelling circumstances” first-filed rule should apply). 56 Frontier Oil Corp. v. RLI Ins. Co., 63 Cal.Rptr.3d 816, 830–31 (Cal. Ct. App. 2007). 57 Id. The “governmental interest analysis” is derived from the Restatement of the Conflict of Laws. Restatement (Second) of Conflict of Laws § 187 (1971). 58 See, e.g., Application Group, 72 Cal.Rptr.2d at 84. 59 The race scenario can be even more complex. If diversity is present and the first party to file files in state court, the second party to file may choose to file in federal court and thereafter remove the earlier state filed case to federal court. Once this is accomplished, the second party to file may seek transfer of the removed case to the federal court in the second party’s state. To make matters even more complex, temporary restraining orders obtained in state court before removal to federal court remain in effect and are governed by Fed.R.Civ.P. 65 from the date of removal. Granny Goose Foods, Inc. v. Brotherhood of Teamsters, 415 U.S. 423, 440 n.15 (1974); 28 U.S.C. § 1450; Pantoja v. Countrywide Home Loans, Inc., 640 F.Supp.2d 1177, 1183 n. 5 (N.D. Cal. 2009) (“Injunctive orders issued by a state court prior to removal remain in full force and effect until dissolved or modified by the district court”) (internal citation and quote omitted).


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• Pay the executive’s attorneys’ fees and costs to obtain a California court judgment invalidating the non-compete agreement; • Pay the executive’s attorneys’ fees and costs to defend a lawsuit or countersuit in whichever jurisdictions the ex-employer may attempt to enforce the noncompete agreement; and • Continue to pay the executive’s salary (or some part of his salary) if a court enters an order prohibiting the executive from working for the prospective employer. If the executive is able to negotiate these terms into his employment agreement, then the risk of loss shifts to the new employer. Whether or not a prospective employer will agree to the executive’s requests depends on the relative leverage of the parties in the employment negotiation. § 10.5.3.4 The Out-of-State Employer’s Attempt to Impose Non-Compete Agreements on California Employees In some circumstances, an employer headquartered outside California (and usually new to the state’s employment market) may attempt to impose a non-compete agreement on its California employees. There are serious potential repercussions for the employer for doing so. Under California law, it is illegal to require a prospective California employee to sign a non-compete agreement.60 The prospective California employee denied employment because he refused to sign a non-compete agreement can sue the prospective employer for wrongful conduct, including unfair competition.61

60

Edwards v. Arthur Andersen LLP, 189 P.3d 285, 294 (Cal. 2008); Dowell v. Biosense Webster, Inc.,102 Cal. Rptr.3d 1, 8–9 (Cal. Ct. App. 2009). 61 Dowell, 102 Cal.Rptr.3d at 8–9. Although there is no doubt that employment-based non-compete agreements violate California law, on a least one occasion, a New York–headquartered company successfully enjoined a California executive from competing in California, based on a non-compete clause in an employment contract that the California resident agreed would be governed by New York law. See Estee Lauder Cos., Inc. v. Batra, 430 F.Supp.2d 158 (S.D.N.Y. 2006).

11 A BR I EF WO R D O N IN TE RN ATION AL IS S UE S A F F E C T I N G T H E E MP LOY M E N T RE L ATION S HIP

this chapter briefly discusses certain issues that may affect the executive who either works abroad or receives foreign-based employee benefits. The purpose of the chapter is to sensitize you to potential international employment issues, not to address every—or even most—international employment issues that may arise.

§ 11.1 Foreign Laws May Apply to the Executive Who Lives and Works in the United States and Never Travels Abroad

The executive who is an American citizen, lives and works in the United States, and never travels abroad may nevertheless be subject to a foreign nation’s laws if he receives one or more foreign-based employment benefits. This situation may arise when a U.S.-based employee works for a foreign company or for a foreign company’s American subsidiary and receives stock, stock options, or bonuses (or other benefits) directly from the foreign entity. The stock of many foreign companies actively trades on foreign stock exchanges, including the London Stock Exchange, Frankfurt Stock Exchange, Tokyo Stock Exchange, and Hong Kong Stock Exchange. Executives may benefit from earning stock in an employer whose stock trades on a foreign stock exchange just as they may benefit from earning publicly traded stock in a U.S.-based employer. However, the executive should understand, before employment begins, what, if any, restrictions or obligations 240

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attach to the stock, and when and under what circumstances the foreign stock may be sold.1 The executive offered stock in a private foreign company should understand the value (or potential value) of what he is receiving before accepting the job. In addition to all of the equity concerns described earlier in this book, there are a host of other questions that must be answered. This includes the most basic question: what does it mean to receive stock in a foreign corporation? Other questions include: What rights attach to the foreign company’s stock? What obligations, if any, attach to the foreign company’s stock? When, if at all, can the foreign company’s stock be sold? What does the law in the foreign company’s country say about the stock? If your executive client does not know the answers to these questions, he is not fully informed; and without full information, he may not be able to negotiate the best employment agreement with his prospective employer. Foreign-based equity grants are not the only sources of concern. All benefits governed by foreign customs or laws should be carefully assessed before employment begins. For example, a bonus or commission plan based, in whole or in part, on foreign-based company metrics may be difficult for the executive to evaluate without knowing the impact of foreign customs on the metrics and the impact of foreign laws on the bonus or commission plan. If the executive is considering joining an employer that grants benefits subject to foreign customs or laws, foreign counsel familiar with the customs and laws at issue should be retained. Only with complete information will the executive be fully prepared to negotiate his employment agreement.

§ 11.2 I.R.C. § 457A May Apply to the Executive Who Lives in the United States and Works for a Foreign Employer

Internal Revenue Code § 457A may apply to executives who receive deferred compensation from a foreign “nonqualified entity.”2 Nonqualified entities include foreign corporations that do not derive “substantially all” of their income from activities in the United States and are not subject to a comprehensive foreign tax.3

1

Brazil’s securities laws provide one example of restrictions that may affect the executive: Under Brazilian law, non-resident investors holding securities in Brazil must choose a Brazilian representative and register with the appropriate Brazilian authority. National Monetary Council (NMC) Resolution no. 2.689/2000, art. 3, available at www.cvm.gov.br/ingl/regu/res2689.asp. Thereafter, non-resident investors must file monthly through their representative. Comissao Valores Mobiliarios (CVM) Rule 325, art. 7, available at http://www.cvm.gov.br/ingl/regu/cvm_325.asp. 2 26 U.S.C. § 457A. 3 26 U.S.C. § 457A(b)(1). Foreign corporations are defined in 26 U.S.C. § 7701(a)(5). I.R.S. Notice 2009-8, Q&A 9 states that the “substantially all” threshold for a foreign entity is 80% of an entity’s gross income. I.R.S. Notice 2009–8 (Jan 26, 2009) is available at http://www.irs.gov/pub/irs-drop/n-09-08.pdf.

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Nonqualified entities also include partnerships (including U.S.-based partnerships) if “substantially all” of the partnership’s income is distributed to tax-exempt organizations or foreign persons not subject to a comprehensive foreign income tax.4 Section 457A subjects non-qualified deferred compensation received from a nonqualified entity to taxation in the year the income vests (when the substantial risk of forfeiture is removed), not the year in which the income is paid.5 If your executive client will work for or receive compensation from a potentially non-qualified § 457A entity, you should become fully familiar with § 457A’s requirements and how they may affect the employment-related clauses the executive negotiates.6

§ 11.3 Foreign Laws Apply When the Executive Works Abroad

When the employee works abroad, whether on a temporary business trip or as a long-term expatriate, he will be subject to foreign countries’ laws. Violation of those laws may lead to serious consequences, including death sentences for conduct that in the United States may not warrant a prison sentence. For example, bribing a public official in the Netherlands subjects the executive to up to four years in prison for violating Dutch anti-corruption statutes,7 in addition to the possibility of a stay in a United States federal penitentiary for violating the American Foreign Corrupt Practices Act.8 Drinking alcohol in public in Saudi Arabia may earn an executive a public lashing.9 Even the casual use of drugs in Singapore may be a capital offense.10 Although foreign laws may be unfamiliar and sometimes draconian, they may also be friendlier than United States law to the American working abroad. Americans (and others) working abroad may be entitled to greater severance and broader protection in employment under a foreign country’s laws, even if they are working for

4

26 U.S.C. § 457A(b)(2). Partnerships are defined in 26 U.S.C. § 7701(a)(2). § 457A(b)(2)(B) and I.R.S. Notice 2009-8, Q&A 11(e)(iii) state that a tax-exempt organization is one which is exempt from taxes under the Internal Revenue Code. I.R.S. Notice 2009-8, Q&A 11 states that the “substantially all” threshold for partnerships is 80% of the partnership’s gross income. 5 Id.; see also I.R.S. Notices 2009–8 (Jan. 26, 2009), 2009–4 C.B. 347. 6 I.R.S. Notice 2009–8 (Jan. 26, 2009), available at www.irs.gov/pub/irs-drop/n-09-08.pdf, provides detailed “interim guidance” on § 457A. 7 Wetboek van Strafrecht [Sr] art. 177 (Neth.). 8 15 U.S.C. §§ 78dd-1, et seq. 9 See, e.g., Adli Hawwari, Getting a Drink in Saudi Arabia, B.B.C. News, Feb. 8, 2001; see also U.S. Dept. of State, 2006 Country Reports on Human Rights Practices: Saudi Arabia (2007) (“[Saudi Arabia] also punished people for various offenses with lashings, including for alcohol-related offenses . . . .”). 10 Misuse of Drugs Act, 2008, c. 185, §§ 2, 33, sched. 2 (Sing.).

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a subsidiary of a U.S.-based company.11 Moreover, § 409A does not apply to an employment agreement’s separation payments and benefits to the extent the payments and benefits are required to comply with foreign law.12 When a foreign-based client asks whether he is better off pursuing his rights against his employer under local law or U.S. law, you should consider the following issues: • Does United States federal law apply to the employee’s situation? • If United States federal law applies, what are the possible outcomes under federal law? • Does the law of one or more states of the United States apply to the employee’s situation? • If one or more states’ laws apply, what are the possible outcomes under state law? • Does the law of a foreign jurisdiction or jurisdictions apply to the employee’s situation? • If one or more foreign jurisdictions’ law applies, what are the possible outcomes under the foreign jurisdictions’ law? • How do the various outcomes compare? Unfortunately, a multijurisdictional analysis is usually more expensive than a single jurisdiction one because multiple lawyers may need to be consulted. In a sense, this is a cost of doing business abroad, although the executive required to pay for the analysis may not look at the situation this way.

11

For example, employees in European Community member countries may have “acquired rights” that protect them in circumstances where those working in America would not be similarly protected. See, e.g., Council Directive 2001/23, 2001 O.J. (L 82) 16-20 (EC), available at http://eur-lex.europa.eu/ LexUriServ/LexUriServ.do?uri=CELEX:32001L0023:EN:NOT. 12 Treas. Reg. § 1.409A-1(b)(9)(iv).

APPENDIX

For Executives and Entrepreneurs: How to Find a Lawyer with Experience Representing Clients Like You

If you are an executive or entrepreneur in need of counsel, there are a number of ways to locate lawyers who regularly represent executives and entrepreneurs. They include: • Ask an experienced lawyer who the best attorney for representing executives and entrepreneurs is in your area. Good lawyers often know leading lawyers in other fields. Then ask the experienced lawyer whether he has any personal experience with the leading attorney he recommends. The personal referral from a knowledgeable source is often a good one. • Ask the leading employment lawyers at a big corporate law firm in your area who they recommend. Big firm lawyers often concentrate on representing employers or their boards but will often know the best to represent the individual on the other side of the table. You are probably best off asking lawyers at big law firms who, as a matter of policy, do not represent individual executives. They are more likely to be objective. • Ask the general counsel (or the most senior in-house labor lawyer) of a large company in your area who he respects most on the other side of the employment table. • Ask other executives and entrepreneurs if they have a lawyer to whom they can refer you. Undoubtedly some will have previously retained an executive employment lawyer. Executives in the process of being fired sometimes feel the most vulnerable because they are embarrassed and believe that they are alone in what appears to be a crushing personal downfall. The executive on the chopping block sans lawyer will be amazed to discover how many of his executive friends have suffered a similar fate (and later recovered). • Search Martindale.com and other Internet sites. Many attorneys advertise and/or have a Web presence. It should not be too difficult to locate attorneys who say they 244

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are experienced in executive negotiations. Beware: Advertising, marketing, and a Web presence do not necessarily mean the attorney is any good. Advertising, marketing, and a Web presence correlate with sales, not necessarily legal ability. Caveat emptor.1

1

An attorney referral service may not be a good source for an executive or entrepreneur lawyer. Many state and local bars have attorney referral services with lists of attorneys that concentrate in a particular area of the law. The problem: Even though the inquirer may be referred to an employment lawyer, there is often little quality control, no matter what the referral service says. A related problem: The attorney referral service may refer to a lawyer on its “employment lawyers” or “labor lawyers” list, and many of these may have little experience representing executives and entrepreneurs.


Table of Authorities

Cases Alex Sheshunoff Mgmt. Serv., L.P. v. Johnson, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .227 Allis-Chalmers Mfg. Co. v. Continental Aviation & Eng’g Corp., . . . . . . . . . . . . . . . . . . . . . . . . .232 Almers v. South Carolina Nat’l Bank of Charleston, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .230 A.L. Williams & Assoc. v. Faircloth, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .230 American Bldgs. Co. v. Pascoe Bldg. Sys., Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231 Andrist v. City of Wanamingo, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204 Application Group, Inc. v. Hunter Group, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120, 235, 236, 238 Applied Materials, Inc. v. Advanced Micro-Fabrication Equip. (Shanghai) Co., . . . . . . . . . . . . .236 Archer Daniels Midland Co. v. Whitacre, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83 Armendariz v. Foundation Health Psychcare Servs., Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .120 Astor v. International Bus. Machs. Corp., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209 Autonation, Inc. v. O’Brien, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .227 Aymes v. Bonelli, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .196 Baker v. General Motors Corp., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237 Basic, Inc. v. Levinson, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163 Bayer Corp. v. Roche Molecular Sys., Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .234 Beard v. Love, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .170 Behradrezaee v. Dashtara, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .170 Bell v. Rimkus Consulting Group, Inc. of La., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .120 Belton v. Sigmon, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 Blackwell; United States v., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162 Blair v. Scott Specialty Gases, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .120 Borden v. Skinner Chuck Co., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75

247

248


Bormann v. AT&T Commc’ns, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209 Bosley Med. Group v. Abramson, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233 Bott v. J.F. Shea Co., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .119 Bowers v. Foto-Wear, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .101 Brehm v. Eisner, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170, 171, 172 Bristol Window and Door, Inc. v. Hoogenstyn, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118 Burge v. Western Pa. Higher Educ. Council, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73 Burton v. Employment Div., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204 Cambridge Eng’g, Inc. v. Mercury Partners 90 BI, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .227 Campbell v. Board of Trustees of Leland Stanford Jr. Univ., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 235 Campbell Soup Co. v. Desatnick, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .228 Cheney v. Automatic Sprinkler Corp. of Am.,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .230 Chiarella v. United States, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110 Chicago Coll. of Osteopathic Med. v. George A. Fuller Co., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .119 Chicago Title Ins. Corp. v. Magnuson, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 Citigroup Shareholder Derivative Litig., In re, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172 Coady v. Ashcraft & Gerel,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .238 Cohen v. Viray, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79 Cole v. Burns Int’l Sec. Servs., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .120 Combined Ins. Co. of Am. v. Hansen, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 Community Hosp. Group, Inc. v. More,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118 Compass Bank v. Hartley, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118 Consolidated Bearings Co. v. Ehret-Krohn Corp., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .119 Cordoba v. Beau Dietl & Assoc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204 Corporate Exp. Office Prods., Inc. v. Phillips, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 Day v. Staples, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163 Deal v. Consumer Programs, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73 Del Monte Fresh Produce, N.A., Inc. v. Chiquita Brands Int’l, Inc., . . . . . . . . . . . . . . . . . . . . . . .227 DeSantis v. Wackenhut Corp.,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .120 DiCerbo v. Commissioner of Dep’t of Employment and Training, . . . . . . . . . . . . . . . . . . . . . . . 204 Digmarc Corp. Derivative Litig., In re, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79 Dirks v. S.E.C., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110 Dobbins, DeGuire & Tucker, P.C. v. Rutherford, MacDonald & Olson, . . . . . . . . . . . . . . . . . . . . .229 Dowell v. Biosense Webster, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 235, 239 D’sa v. Playhut, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 235 EarthWeb, Inc. v. Schlack, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 Edwards v. Arthur Andersen LLP, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 230, 235, 239 Eichelkraut v. Camp, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 212 E.I. duPont de Nemours & Co. v. American Potash & Chem. Corp., . . . . . . . . . . . . . . . . . . . . . . .232 E.P.I. of Cleveland, Inc. v. Basler, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118 Equity Ins. Managers of Ill. LLC v. McNichols,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73 Erie R. Co. v. Tompkins, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237 Estee Lauder Cos., Inc. v. Batra, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .239 Felmlee v. Lockett, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231 First City Nat’l Bank & Trust Co. v. Simmons, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .238 First Pac. Bancorp.; S.E.C. v., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162


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FLIR Sys., Inc. v. Parrish, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232, 234 Food Fair Stores, Inc. v. Greeley, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .230 Frontier Oil Corp. v. RLI Ins. Co., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .238 Gagliardi v. TriFoods Int’l, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172 Ganino v. Citizen Utilities Co., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163 Gault South Bay Litig., In re, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .236 General Commercial Packaging, Inc. v. TPS Package Eng’g, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . 235 General Elec. Co. v. Sung, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231 GES Exposition Servs., Inc. v. Floreano, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .229 Gibson v. Nye Frontier Ford, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .120 Gleeson v. Preferred Sourcing LLC, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118 Globespan, Inc. v. O’Neill, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .234 Graham v. Hudgins, Thompson, Ball & Assocs., Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .230 Granny Goose Foods, Inc. v. Brotherhood of Teamsters, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .238 Great Frame Up Sys. v. Jazayeri Enters., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237 Gruver v. Midas Int’l Corp.,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209 Guiliano v. Cleo, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73 Harris v. School Annual Pub. Co., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 212 Higgins v. New York Stock Exch., Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .170 Hilligoss v. Cargill, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .227 Hyde v. Lewis, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209 Hydrofarm, Inc. v. Orendorff, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 IKON Office Solutions, Inc. v. Dale, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118 International Bus. Mach. Corp. v. Bajorek, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 235 Jedwab v. MGM Grand Hotels, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28 Jeeber v. Convergys Corp., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118 Jenkins; S.E.C. v., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77 Johnson v. MPR Assocs., Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .228 JustMed, Inc. v. Byce,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .196 Kansas Heart Hosp. LLC v. Idbeis, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .170 Keener v. Convergys Corp., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118 Kittredge v. McNerney, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73 Klaxon Co. v. Stentor Elec. Mfg. Co., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237 Krisst v. Whelan,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .229 Lacey v. Edwards, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .230 L&B Transp. LLC v. Beach, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118, 227 Lawrence & Allen, Inc. v. Cambridge Human Res. Group, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .227 LeJeune v. Coin Acceptors, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 Liano; People v., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237 Lincoln Elec. Co. v. St. Paul Fire and Marine Ins. Co., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118 Local 134 IBEW Joint Pension Trust of Chi. v. JP Morgan Chase Co., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163 Lucent v. International Bus. Machs. Corp.,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .230

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MacGinnitie v. Hobbs Group, LLC, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 Malone v. Brincat,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28 Maltby v. Harlow Meyer Savage, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .228 Marietta Corp. v. Fairhurst, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 Massingill v. Stream, Ltd., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .196 Mayer Hoffman McCann, P.C. v. Barton,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .229 Mayhew; S.E.C. v., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163 McKissick v. Yuen, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 208 Meakins v. Huiet, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204 Merck & Co. v. Lyon, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Haydu, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .238 Metropolitan Life Ins. Co. v. Glenn, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .194 Miller v. American Tel. & Tel. Co., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172 Miller v. Associate Pension Trusts, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .229 Morris v. Schroeder Capital Mgmt. Int’l, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .230 Morrison v. Circuit City Stores, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .120 MTV Networks v. Fox Kids Worldwide, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .228 Muggill v. Reuben H. Donnelley Corp., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .230 Nedlloyd Lines B.V. v. Superior Court, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 235 Noonan v. Staples, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83 No. 84 Employer-Teamster Joint Council Pension Tr. Fund v. America W. Holding Corp., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163 O’Hagan; United States v.,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163 Open Magnetic Imaging, Inc. v. Nieves-Garcia, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .227 Oubre v. Entergy Operations, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .210 Overholt Crop Ins. Serv. Co. v. Travis, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94 Pantoja v. Countrywide Home Loans, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .238 Patlovich v. Rudd, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 212 PepsiCo., Inc. v. Redmond, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 PFPC Worldwide Inc. v. Lemay, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209 Phoenix Capital, Inc. v. Dowell, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 Pirelli Armstrong Tire Corp. Retiree Med. Benefits Trust ex rel. Fed. Nat’l Mortgage Ass’n v. Raines,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79 PMC, Inc. v. Kadisha, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231 Post v. Merrill Lynch, Pierce, Fenner & Smith, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .230 Pressman v. Franklin Nat’l Bank, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .119 Ramirez v. Yosemite Water Co., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75 Rochester Corp. v. Rochester, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .229 Rosenberg v. Salomon, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83 Rosser v. Raytheon Excess Pension Plan, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209 Roth v. Speck, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73 Rothschild Int’l Corp. v. Liggett Group, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28 Rouch v. Enquirer & News of Battle Creek Mich., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 212 Royer; United States v., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163


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Sadler v. Jorad, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .170 Saxe v. Brady, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172 Schachter v. Citigroup, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .76 Schwimmer; United States v., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118 Scientific Drilling Int’l, Inc. v. Pathfinder Energy Servs., Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84 S.E.C. v. Jenkins,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77 Shoen v. SAC Holding Corp., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .170 Smith v. Unemployment Appeals Comm’n, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204 Snarr v. Picker Corp., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .230 Sogeti USA LLC v. Scariano, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 Space Aero Prods. Co. v. R.E. Darling Co., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231 Stamp v. Touche Ross & Co., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .169 Stipp v. Wallace Plating, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .229 Storetrax v. Gurland, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .169 Strata Mktg., Inc. v. Murphy, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 Stuart v. Radioshack Corp., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .236 Summers v. Cherokee Children & Family Servs., Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .170 Sznewajs v. U.S. Bancorp, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74 Talbot; S.E.C. v., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163 Tatom v. Ameritech Corp., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .229 Taylor Bldg. Corp. of Am. v. Benfield, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .120 Teicher; United States v., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110 Texas Gulf Sulfur Co.; S.E.C. v., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110 Thiesing v. Dentsply Int’l, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .228 TSC Indus., Inc. v. Northway, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163 Tyson Foods, Inc., In re, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172 Vacco Indus., Inc. v. Van Den Berg, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .234 Van Pelt v. Berefco, Inc.,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .229 Viad Corp. v. Houghton, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .229

Walling v. Plymouth Mfg. Corp., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75 The Walt Disney Co. Derivative Litig., In re, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169, 170, 172 Weir v. Anaconda Co., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83 Wien & Malkin LLP v. Helmsley-Spear, Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118 Wilks v. Pep Boys, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75 Williams v. Jader Fuel Co., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .118 Willmschen v. Trinity Lakes Improvement Ass’n, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .170 Winston Res. Corp. v. Minnesota Mining and Mfg. Co.,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231 World Info. Techs.; S.E.C. v., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162 Wyeth v. King Pharm., Inc., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .119 YourNetDating, Inc. v. Mitchell, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231 Zaluski v. United Am. Healthcare Corp., . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163 Zimmer, Inc. v. Sharpe, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .227 Zupnick v. Goizueta,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 172

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Table of Laws and Regulations Federal Laws and Regulations Age Discrimination in Employment Act of 1967 (ADEA) . . . . . . . . . . . . . . . . . . . . . . . .167, 208, 210 American Jobs Creation Act of 2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95 American Recovery and Reinvestment Act of 2009 (ARRA) . . . . . . . . . . . . . . . . . .77, 168, 169, 206 Americans with Disabilities Act of 1990 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 Civil Rights Act of 1964 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 Civil Rights Act of 1991 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 Commodity Exchange Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 Computer Fraud and Abuse Act (CFAA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231– 232 Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) . . . . . . . . . . . . . . . . . . . . . . . 15 Constitution, U.S. Art. IV, §1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237 Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 generally . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 §§748-749 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 §§922-924 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 §951 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26, 27, 158 §951(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .158 §952 26,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33 §953 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 §954 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65, 77, 79 §955 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 §956 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 §956(a)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 §956(a)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 §956(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 §956(f) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 Economic Espionage Act of 1996 (EEA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 Emergency Economic Stabilization Act of 2008 (EESA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168, 169 Employee Retirement Income Security Act of 1974 (ERISA) . . . . . . . . . . . . . . . . . . . . . . . . . . 15, 167 Equal Pay Act of 1963 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168 Fair Labor Standards Act of 1938 (FLSA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167 Family and Medical Leave Act of 1993 (FMLA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167–168 Federal Deposit Insurance Act §8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 Foreign Corrupt Practices Act of 1977 (FCPA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166 Gramm-Leach-Bliley Act §505 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 Internal Revenue Code generally. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175 §55 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 §83(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87, 88 §83(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36, 87, 184 §105 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .107 §106 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .107 §162(m) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 §162(m)(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160


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§162(m)(4)(C) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 §162(m)(4)(E)(ii) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 §162(m)(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .169 §162(m)(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 §280G . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12, 23, 24, 117, 140, 147, 157, 158, 179, 180 §280G(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 §280G(b)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .116 §280G(b)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115, 116 §280G(b)(2)(A)(ii) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 §280G(b)(2)(C) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .116 §280G(b)(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .116 §280G(b)(5)(B)(i) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157 §401(a)(13) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .114 §401(a)(31) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .114 §401(k)(13)(D)(iii). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .114 §409A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11, 12, 24, 82, 83, 84, 87, 95–100, 102–107, 113, 115, 133, 139, 147, 177, 179, 181, 182, 205 §409A(a)(1)(A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95, 96 §409A(a)(1)(B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 §409A(a)(2)(A)(i) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 §409A(a)(2)(A)(ii) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 §409A(a)(2)(A)(iii) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 §409A(a)(2)(A)(iv) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 §409A(a)(2)(A)(v) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97, 144 §409A(a)(2)(A)(vi) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 §409A(a)(2)(B)(i) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104, 105, 140 §409A(a)(2)(B)(ii)(I) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 §409A(a)(2)(B)(ii)(II) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 §409A(a)(2)(C) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 §409A(a)(4)(C) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 §409A(d)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 §409A(d)(1)(A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95 §409A(d)(1)(B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95 §409A(d)(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96 §416(i)(1)(A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104 §422(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88, 89 §422(a)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 §422(b)(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .81 §422(b)(2)-(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .81 §422(d) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 §423 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38 §423(a)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38 §423(b)(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38 §423(b)(8) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38 §457A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .241, 242 §457A(b)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .241 §457A(b)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .242 §457A(b)(2)(B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .242 §4975(e)(7) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .39

254


§4999 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12, 23, 24, 115, 116, 117, 140, 147, 179, 180 §6432 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206 §7701(a)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .242 §7701(a)(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .241 Investment Advisers Act of 1940 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 Investment Company Act of 1940 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 Misuse of Drugs Act of 2008 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .242 Occupational Safety and Health Act of 1970 (OSHA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 Older Workers Benefit Protection Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 Rehabilitation Act of 1973 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 Sarbanes-Oxley Act of 2002 generally . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 §302 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 §304 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77, 79, 160 §402 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .42 §402(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 Securities Act of 1933 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 Securities and Exchange Act of 1934 generally . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12, 64, 161 §10(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162 §10C . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 §10C(a)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 §10C(a)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 §10C(a)(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 §10C(a)(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 §10C(b)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33 §10C(c)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 §10C(c)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33 §10C(e) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 §10D . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77 §10D(b)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 §10D(b)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77 §13(d) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175 §14(d) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175 §14(i) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 §14(j) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 §14A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 §14A(a)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27 §14A(a)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27 §14A(b)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .158 §14A(b)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .158 §14A(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27, 158 §14A(e) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .158 §16(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166 §21E . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 Trust Indenture Act of 1939 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 Uniformed Services Employment and Reemployment Rights Act of 1994 . . . . . . . . . . . . . . . . .168 Uniform Trade Secrets Act (UTSA) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231 Worker Adjustment and Retraining Notification (WARN) Act . . . . . . . . . . . . . . . . . . . . . . . 167, 201


255

U.S. Code 7 U.S.C. §§1, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168 11 U.S.C. §101(31)(B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106 11 U.S.C. §503(c)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148 11 U.S.C. §503(c)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106 12 U.S.C. §1818 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65 12 U.S.C. §5221 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .169 12 U.S.C. §5221(a)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77 12 U.S.C. §5221(b)(2)(B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77 12 U.S.C. §5221(b)(3)(B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77 12 U.S.C. §5221(b)(3)(C) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .169 12 U.S.C. §5221(e) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27 15 U.S.C. §§77a, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161 15 U.S.C. §§77aaa, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161 15 U.S.C. §§78, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26, 27 15 U.S.C. §§78a, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64, 161, 168 15 U.S.C. §78c(a)(8) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 15 U.S.C. §§78dd-1, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166, 242 15 U.S.C. §78dd-1(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166 15 U.S.C. §78ff(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162 15 U.S.C. §78j . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110, 162 15 U.S.C. §78l . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110 15 U.S.C. §78l(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 15 U.S.C. §78m . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110 15 U.S.C. §78m(k) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .42 15 U.S.C. §78m(k)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 15 U.S.C. §78m(k)(1)-(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 15 U.S.C. §78p . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166 15 U.S.C. §78p(a)(1). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 15 U.S.C. §78p(a)(3). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 15 U.S.C. §78p(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166 15 U.S.C. §78r(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162 15 U.S.C. §§78t-1, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12, 67 15 U.S.C. §78t-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162 15 U.S.C. §78u . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162 15 U.S.C. §78u(d)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162 15 U.S.C. §78u-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162 15 U.S.C. §§80a-1, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161 15 U.S.C. §§80b-1, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161 15 U.S.C. §7201(7) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 15 U.S.C. §7241 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 15 U.S.C. §7243 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77, 160 17 U.S.C. §101 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .196 17 U.S.C. §106 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .196 17 U.S.C. §201 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .196 18 U.S.C. §1030 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 18 U.S.C. §1030(c)(3)(B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .234 18 U.S.C. §1030(e)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .234 18 U.S.C. §1030(g). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231

256


18 U.S.C. §§1342-1343 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166 18 U.S.C. §§1831-1839 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 18 U.S.C. §1831 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233 18 U.S.C. §1831(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233 18 U.S.C. §1832 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233 18 U.S.C. §1832(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233 18 U.S.C. §1952 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .166 18 U.S.C. §3571(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 233 26 U.S.C. See Internal Revenue Code 28 U.S.C. §1450 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .238 29 U.S.C. §§201, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167 29 U.S.C. §206 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 29 U.S.C. §209 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 29 U.S.C. §211 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 29 U.S.C. §213 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 29 U.S.C. §213(a)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75 29 U.S.C. §§215-219 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 29 U.S.C. §§255-256 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 29 U.S.C. §§259-260 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 29 U.S.C. §262 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 29 U.S.C. §621 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 29 U.S.C. §§621-634. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167, 210 29 U.S.C. §623 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 29 U.S.C. §626 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 29 U.S.C §626(f)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .210 29 U.S.C. §626(f)(1)(F)(ii) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .210 29 U.S.C. §628 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 29 U.S.C. §630 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 29 U.S.C. §660(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 29 U.S.C. §§701 et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167 29 U.S.C. §§1001, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15, 39 29 U.S.C. §1053 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167, 229 29 U.S.C. §1140-1141. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 29 U.S.C. §§1161, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 29 U.S.C. §§2101, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 201 29 U.S.C. §2102(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167, 210 29 U.S.C. §§2601, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168 38 U.S.C. §§4301-4333 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 42 U.S.C. §1981 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 42 U.S.C. §§2000e, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167 42 U.S.C. §§12101, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167 47 U.S.C. §225 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 Treasury Regulations (Treas. Reg.) §1.83-7 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 §1.280G-1, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 §1.280G-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23 §1.280G-1, Q&A 7(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157


257

§1.280G-1, Q&A 9 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .116 §1.280G-1, Q&A 13 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 §1.280G-1, Q&A 22 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .116 §1.280G-1, Q&A 24 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .116 §1.280G-1, Q&A 25 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .116 §1.280G-1, Q&A 30 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115, 116 §1.280G-1, Q&A 34 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115 §§1.409A, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82 §§1.409A-1, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24, 83 §1.409A-1(a)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .95 §1.409A-1(a)(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 177 §1.409A-1(a)(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .107 §1.409A-1(b)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 §1.409A-1(b)(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 §1.409A-1(b)(4)(i)(A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97, 205 §1.409A-1(b)(5)(i) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .82 §1.409A-1(b)(5)(iii)(A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84 §1.409A-1(b)(5)(iv)(A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .82 §1.409A-1(b)(5)(iv)(B)(2)(i) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .82 §1.409A-1(b)(5)(v)(A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83 §1.409A-1(b)(5)(v)(B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .83 §1.409A-1(b)(5)(v)(C)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 206 §1.409A-1(b)(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .87 §1.409A-1(b)(9)(i) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .205 §1.409A-1(b)(9)(iii) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98, 205 §1.409A-1(b)(9)(iii)(B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 §1.409A-1(b)(9)(iv) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .243 §1.409A-1(b)(9)(v)(A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 §1.409A-1(b)(9)(v)(B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .107 §1.409A-1(b)(9)(v)(C) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 §1.409A-1(b)(9)(v)(D) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 §1.409A-1(b)(9)(v)(E) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 §1.409A-1(b)(11) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .205 §1.409A-1(c)(2)(i)(E). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 §1.409A-1(c)(3)(v) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .105 §1.409A-1(h) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100, 105, 138 §1.409A-1(i) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105, 140 §1.409A-1(i)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104 §1.409A-1(m) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 §1.409A-1(n) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .97 §1.409A-1(n)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98, 99 §1.409A-1(n)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 §1.409A-1(n)(2)(i) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .102 §1.409A-1(n)(2)(ii) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 §1.409A-1(n)(2)(ii)(A). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103 §1.409A-1(n)(2)(ii)(A)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .102 §1.409A-1(n)(2)(ii)(A)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103 §1.409A-1(n)(2)(ii)(A)(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103 §1.409A-1(n)(2)(ii)(A)(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103

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§1.409A-1(n)(2)(ii)(A)(5) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103 §1.409A-1(n)(2)(ii)(A)(6) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103 §1.409A-1(n)(2)(ii)(B). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99, 103 §1.409A-1(n)(2)(ii)(C). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .103 §1.409A-2(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 §1.409A-2(b)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .139 §1.409A-3(i)(1)(iv)(A)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 §1.409A-3(i)(1)(iv)(A)(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 §1.409A-3(i)(5)(v)(A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144 §1.409A-3(i)(5)(vi)(A)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144 §1.409A-3(i)(5)(vi)(A)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .145 §1.409A-3(i)(5)(vii)(A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .145 §1.422-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88, 89 §1.422-1(a)(1)(i)(B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 §1.422-4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89 §1.423-2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38 Code of Federal Regulations Exchange Act Releases No. 34-63124 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27, 158 I.R.S. Notices 2009-8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .242 2009-8, Q&A 9 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .241 2009-8, Q&A 11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .242 2009-8, Q&A 11(e)(ii) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .242 12 C.F.R. §220.3(e)(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 111 17 C.F.R. pt. 228. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 17 C.F.R. pt. 229 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65, 159 17 C.F.R. §229.103 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 17 C.F.R. §229.402 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26, 64, 65 17 C.F.R. §229.402(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160 17 C.F.R. §229.402(a)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 17 C.F.R. §229.402(a)(2)-(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27, 64, 159 17 C.F.R. §229.402(a)(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 17 C.F.R. §229.402(a)(6)(ii) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 17 C.F.R. §229.402(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .64, 159 17 C.F.R. §229.407 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26, 32 17 C.F.R. pt. 230. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 17 C.F.R. §230.428 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110 17 C.F.R. pt. 232 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .64, 159 17 C.F.R. pt. 239 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65, 159 17 C.F.R. §239.16b . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110 17 C.F.R. pt. 240 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65, 159, 161 17 C.F.R. §240.10b-5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110, 162 17 C.F.R. §240.10b5-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163 17 C.F.R. §240.10b5-1(c)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163, 164 17 C.F.R. §240.10b5-1(c)(1)(i)(A)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .163 17 C.F.R. §240.10b5-1(c)(1)(i)(B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .164 17 C.F.R. §240.10b5-1(c)(1)(i)(C) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .164


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17 C.F.R. §240.10b5-1(c)(1)(ii) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .164 17 C.F.R. §240.13a-11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 17 C.F.R. §240.14a-101 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 17 C.F.R. §240.15d-11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 17 C.F.R. pt. 245 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .64, 159 17 C.F.R. pt. 249 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65, 159 17 C.F.R. §249.104 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 17 C.F.R. §249.105 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 17 C.F.R. §249.308 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 17 C.F.R. pt. 260 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 17 C.F.R. pt. 270. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 17 C.F.R. pt. 274 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65, 159 17 C.F.R. pt. 275 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .161 26 C.F.R. See Treasury Regulations 29 C.F.R. pt. 825 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 29 C.F.R. pts. 1620-1621 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168 29 C.F.R. pts. 1625-1626 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 29 C.F.R. §1625.23 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .210 31 C.F.R. pt. 30 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .168, 169 31 C.F.R. §30.1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .169 31 C.F.R. §30.9 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .169 31 C.F.R. §31.16 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .169 41 C.F.R. §§60-741 to 60-742 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .167 SEC Form 8-K Item 5.02(e)-(f) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 S.E.C. Regulation S-K Item 402. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26, 64, 159 Item 407(e)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26 SEC Schedule 14A Item 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 S.E.C. Rules 10-b5. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .162 10b5-1 Q&A 15(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .164 10b5-1 Q&A 15(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .164 13A-11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 15d-11 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .159 Securities Act Releases No. 33-7881 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .110 No. 33-9153 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27, 158

260


State Laws and Regulations Arizona Ariz. Rev. Stat. Ann. §23-1025 . . . . . . . . . . . 209 California Calif. Business and Professions Code §16600 . . . . . . . . . . . . . . . . . . . . 41, 233, 235, 236 §16601 . . . . . . . . . . . . . . . . . . . . . . . . . . .233, 234 §16602 . . . . . . . . . . . . . . . . . . . . . . . . . . .233, 234 §16602.5 . . . . . . . . . . . . . . . . . . . . . . . . . .233, 234 Calif. Civil Code §§44-46 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .212 §1542 . . . . . . . . . . . . . . . . .115, 208, 218, 223, 224 §1642. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .123 §3426.1-11. . . . . . . . . . . . . . . . . . . . . . . . . . . . .231 Calif. Labor Code §2800 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114 §2802 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114 §2804 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114 §2870 . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39, 124 §5001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 209 Calif. Unemployment Ins. Code §1342 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114 Calif. Code Regs. Title 10 §260.140.8(b)(4) . . . . . . . . . . . . . . . . 84 Title 10 §260.140.41(e) . . . . . . . . . . . . . . . . . . 84 Colorado Colo. Rev. Stat. §18-13-105 . . . . . . . . . . . . . . . . . . . . . . . . . .212 Connecticut Conn. Gen. Stat. §31-296 . . . . . . . . . . . . . . . 209 Delaware Del. Code Ann. Title 6 §2001-09 . . . . . . . . . . . . . . . . . . . . . . .231 Title 8 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170 Title 8 §141(e) . . . . . . . . . . . . . . . . . . . . . . . . 170 Title 8 §157(b) . . . . . . . . . . . . . . . . . . . . . . . . . 81 Title 8 §157(c) . . . . . . . . . . . . . . . . . . . . . . . . . 81 District of Columbia D.C. Code §§36-401, et seq . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231 D.C. Rules of Prof’l Conduct, Rule 1.8(e) . . . . . . . . . . . . . . . . . . . . . . . . . . 90

Florida Fla. Stat. §443.051 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114 §542.335(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . 228 §607.0621 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 §§688.001-09 . . . . . . . . . . . . . . . . . . . . . . . . . .231 Georgia Ga. Code Ann. §51-5-1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .212 §51-5-4 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .212 Idaho Idaho Code Ann. §18-4801. . . . . . . . . . . . . . .212 Illinois 765 Ill. Comp. Stat. §1065/1-9 . . . . . . . . . . . . . . . . . . . . . . . . . . .231 805 Ill. Comp. Stat. §5/6.25(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 Illinois Trade Secret Act . . . . . . . . . . . . . . . . 232 Indiana Ind. Code §22-3-10-1 . . . . . . . . . . . . . . . . . . . 209 Louisiana La. Rev. Stat. Ann. §23:1693. . . . . . . . . . . . . 114 La. Rules of Prof’l Conduct, Rule 1.8(f) . . . . . . . . . . . . . . . . . . . . . . . . . . 90 Massachusetts Mass. Gen. Laws §25(e)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204 §151A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204 §151A 35-36. . . . . . . . . . . . . . . . . . . . . . . . . . . 114 Mass. Rules of Prof’l Conduct, Rule 1.8(f) . . . . . . . . . . . . . . . . . . . . . . . . . . 90 Michigan Mich. Comp. Laws §408.477 . . . . . . . . . . . . . 78 Minnesota Minn. Stat. §268.095 . . . . . . . . . . . . . . . . . . 204 Misouri Mo. Rev. Stat. §288.380 . . . . . . . . . . . . . . . . 114 New Jersey N.J. Stat. Ann. §34:15-39 . . . . . . . . . . . . . . . 209

Table of Authorities New York N.Y. Labor Law §193 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 §593(1)(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204 §595 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114 N.Y. Prof’l Conduct Rules, Rule 1200.08(f) . . . . . . . . . . . . . . . . . . . . . . 90 Ohio Ohio Rules of Prof’l Conduct, Rule 1.7 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .153 Oregon Ore. Rev. Stat. §657.176(2)(c). . . . . . . . . . . . . . . . . . . . . . . 204 Rhode Island R.I. Rules of Prof’l Conduct, Rule 1.7 . . . . . .153

261

Texas Tex. Bus. Com. Code Ann. §15.50(a). . . . . . . . . . . . . . . . . . . . . . . . . . . 227 2 Tex. Bus. Orgs. Code Ann. §21.157 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 81 Tex. Labor Code §61.018 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 §207.071 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114 §207.072 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114 §207.073 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114 §207.074 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114 Tex. Rules of Prof’l Conduct, Rule §1.08(e) . . . . . . . . . . . . . . . . . . . . . . . . 90 Virginia Va. Rules of Prof’l Conduct, Rule 1.7 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .153


Index

Accelerated vesting, 95, 108, 116, 127–128, 132, 146–147, 206 Accounting experts, 24 Acquisitions. See Mergers and acquisitions ADRs (American Depositary Receipts), 64n1 Age discrimination, 192n6 Age Discrimination in Employment Act (ADEA), 167, 208n27, 210n35 Amendment clauses, 118–119n149 American Arbitration Association, 41 American Depositary Receipts (ADRs), 64n1 American Jobs Creation Act of 2004, 95 American Recovery and Reinvestment Act of 2009, 77n28, 168, 169n81 Americans with Disabilities Act of 1990, 167 Anti-blackout clauses, 109–112 Anti-buy-back provisions, 84, 84n47 Anti-dilution clauses, 86–87n48 Anti-equity forfeiture provisions, 83–84 Apple, 64 Arbitration agreements confidential information and invention assignment agreements, 125 description of documents, 41

263

employment agreement provision, 119–120, 120n151 Assignment clauses, 117 Attorneys’ fees agreements, 49–50 employment agreement’s reimbursement clauses, 90 severance agreements, reimbursement agreements, 207 At-will employment clauses, 9, 13–14, 72–73, 125, 131 Bad faith, 172, 172–173n103 “Bailouts.” See American Recovery and Reinvestment Act of 2009; Emergency Economic Stabilization Act of 2008; Troubled Asset Relief Program (TARP) Bankruptcy Code, 106n114 Bankruptcy Court, 148n9 Best efforts clauses, 73–74 Bluntness, importance of, 5 Boards of directors, 26–29, 81–82, 170–173 Bonus plans, 35, 52, 75–76 Brazil, securities laws in, 241n1 Bridge loans, 45

264

Index

Business advice anecdotes, 13 cause, negotiating definition of, 12–13 legal advice vs., 11–13 role of attorney, 22, 23 Business expense reimbursement clauses, 206 Business judgment rule, 169–173 in Delaware, 169–170n85, 170–172, 172–173n103 duty of care, 169–170n85 duty of loyalty, 169–170, 170n86 fraud, bad faith, or self-dealing, 172, 172–173n103 waste, 170–171, 172n99 Buy-back provisions, 84, 84n47 California anti-equity forfeiture provisions, 84, 84n45 certificates of incorporation, 44n20 commissions, 76, 76n24 confidential information and invention assignment agreements, 39, 39n15, 124 indemnification, 115 non-compete agreements. See Noncompete agreements in California Public Employees’ Retirement System (CalPERS), 27–28, 27n12 releases, 115 Capital investment, 43–46. See also Investor agreements; Venture capital bridge loans, 45 investor agreements, 45 preferred stock, 43–44 registration agreements, 45, 45n21 stock purchase agreements, 44–45 voting rights agreements, 45 warrants, 45–46 Capitalization table (“cap table”), 66–67 Carril, Peter, 54n12 Carve-outs description of documents, 40 negotiation, 147–148 from releases, 113–114, 114n129 reviewing, 52 in severance agreements, 208 Cause for termination

at-will employment clauses, 72–73 maximizing protection of clients, 14–15, 125 motivations of employer, 15, 83–84 negotiating definition of, 12–13, 125, 139 non-qualified deferred compensation, 98–100 termination without cause clauses, 100–102 Certificates of incorporation, 44, 44n20, 67 CFAA (Computer Fraud and Abuse Act), 231–233 Change in control agreements, 143–147. See also Mergers and acquisitions deferred compensation, 144, 147 description of documents, 40 “double trigger” agreements, 105–106, 108, 145, 147 reviewing, 52 sample agreement, 174–182 severance agreements, 146 “single trigger” agreements, 105–106, 108, 145, 145n7 standard provisions, 143–144 Treasury Regulations, 144–145 CIIAA. See Confidential information and invention assignment agreements Civil Rights Act of 1964, 167 Civil Rights Act of 1991, 167 “Clawback” clauses compensation clauses, 77–79, 77n28, 79n31 severance agreements, 213–214 Clients chronology of events, 48, 49, 51–52, 194 difficult clients, 54–55 due diligence of clients, 53 intake process, 47–50 obtaining information, 50n3 reviewing relevant documents, 52–53 telephone interviews, 48–49 COBRA benefits, 15, 95, 106–107, 127, 137, 138, 206, 206n24 Commission plans, 35, 52, 75–76, 75n22 Common stock, 28n15, 36, 37, 43–44, 66–67, 82, 86, 96, 129–130 Company policies description of documents, 42 employment agreements, 93

Index separation agreements, 192 Compensation clauses, 74–79 base salary, 75 bonus plans, 75–76 commission plans, 75–76, 75n22 life insurance policies, 74 mortgage assistance, 74 perquisites, 74 professional expense reimbursement, 75 relocation assistance, 74 tax gross-ups, 74 top-hat deferred compensation, 74–75n20 Compensation committees, 26–27 Compensia, Inc., 32 Compete and forfeit agreements, 228–230 Computer Fraud and Abuse Act (CFAA), 231–233 Confidential information and invention assignment agreements (CIIAA) arbitration clauses, 52, 125 at-will employment clauses, 125 in California, 39, 39n15, 124 continuing agreements clauses, 207–208 description of documents, 39–40, 39n14 in employment agreements, 39–40, 93 inappropriate requirements for clients, 124–125, 125n157 overly broad definitions, 124 proprietary information protection, 230–231 reviewing, 52 right to disclose, 125 standard provisions, 123–124 trade secret protection, 230–231 Confidentiality clauses, 210–211 Confirmation of parties’ entry into other agreements, 94 Conflicts of interest in ERISA severance plans, 194n9 Consolidated Omnibus Budget Reconciliation Act. See COBRA benefits Consolidation. See Mergers and acquisitions (M&A) Constituent interests of employers, 25–30 Constraints on negotiation, 159–173 ADEA, 167 American Recovery and Reinvestment Act of 2009, 168, 169n81

265

Americans with Disabilities Act of 1990, 167 business judgment rule. See Business judgment rule Civil Rights Act of 1964, 167 Dodd–Frank Act, 168, 168n Emergency Economic Stabilization Act of 2008, 168, 169n81 Equal Pay Act of 1963, 168 ERISA, 167 Fair Labor Standards Act of 1938, 167 Family and Medical Leave Act of 1993, 167–168 FCPA, 166 IRC §162(m) cash compensation deduction limit, 160, 160n29 leverage and, 10 Older Workers Benefit Protection Act, 167 OSHA, 168 public company reporting obligations, 159–160, 160n29 Rehabilitation Act of 1973, 167 Rule 10b-5, 162, 162n43 Sarbanes–Oxley Act of 2002, 160–161 SEC rules, 161–163, 162n43 securities laws, 161–163 short swing profits, 166 TARP, 168–169 10b5-1 trading plans, 163–165, 163n46 Uniformed Services Employment and Reemployment Rights Act of 1994, 168 WARN Act, 167 Constructive termination. See Good reason for resignation Consultants, 31–33 compensation consultants, 32–33 executive search firms, 31–32 Consulting agreements, 43 Continuing agreements clauses, 207–208, 208n26 Contracts. See specific agreement Cooperation clauses, 213 Counterparts and signing clauses, 123 Covenants not to sue, 208–209, 208–209n29 Cram down, 156–157 Creative contractual provisions, 11

266

Index

D&O insurance. See Directors and officers (D&O) insurance Death benefits, 112 Deferred compensation business vs. legal advice, 11–12 change in control agreements, 144, 147 employment agreements, 115 international issues, 241–243, 241n3, 242n4 non-qualified deferred compensation, 95–100 severance agreements, 95–100, 102, 205, 205n23 top-hat deferred compensation, 74–75n20 Delaware business judgment rule, 169–170n85, 170–172, 172–173n103 certificates of incorporation, 44, 44n20, 67 private company investors, 28–29, 28n15 stock options, 81, 81n33 Departure clauses, 203–204, 204n20. See also Severance agreements Difficult clients, 54–55 Dilution, 70–71, 86–87n48, 129. See also Overhang Direct negotiation, 56–57 Directors and officers (D&O) insurance, 43, 90n59, 92–93 Disability benefits, 112 Disclosure requirements, 64–65, 160–161 Dispute resolution clauses, 119–120, 120n151. See also Arbitration agreements Diversity of employers, 24–25 Documents, 34–46 arbitration agreements, 41 bonus plans, 35 capital investment, 43–46 carve-outs, 40 change in control agreements, 40 commission plans, 35 company policies, 42 confidential information and invention assignment agreements, 39–40, 39n14 consulting agreements, 43 employee benefit plans, 41–42 employee handbooks, 42 employer control of documents, 59 employment agreements, 35 equity agreements, 35–39

indemnification agreements, 41 insurance policies, 43 loans to clients, 42 non-compete agreements, 40–41 offer letters, 34–35, 35n1 performance improvement plans, 43 retention agreements, 40 severance agreements, 42 Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 “clawback” provisions, 77–79, 77n28 compensation committee rules, 26–27, 33n31 compensation consultant rules, 32–33 M&A, §951(b) vote, 158 named executive officers, 26–27n10 reporting obligations, 64–65, 65n9 whistleblower protection, 168, 168n “Double trigger” agreements change in control agreements, 145, 147 severance agreements, 15, 105–106 Due diligence of clients, 53, 63 Duty of care, 169–170n85 Duty of loyalty, 169–170, 170n86 E&O insurance. See Errors and omissions (E&O) insurance Economically irrational conduct, 18 Economic Espionage Act of 1996 (EEA), 232–233 Educating clients about employment agreements, 68–71 anecdotes, 69–70 ensuring client thinks through all issues, 68–69 importance of, 3 legal advice, 53–54 M&A process, 149 market–equity ranges, 70–71 offer letters, sample letter to client, 71 EEA (Economic Espionage Act of 1996), 232–233 Egon Zehnder International, 32 Emergency Economic Stabilization Act of 2008, 77n28, 168, 169n81 Employee benefit plans, 41–42 Employee benefits clauses, 89 Employee handbooks description of documents, 42

Index employment agreement provision, 93 Employee restricted stock unit (RSU) agreements, 37 Employee Retirement Income Security Act of 1974 (ERISA) constraints on negotiation, 167 severance plans, 15, 65–66, 193–194, 201 Employee stock option agreements, 36–37 Employee stock ownership plans (ESOPs), 39 Employee stock purchase plans (ESPPs), 38 Employers attorneys, 30 boards of directors, 26–27 compensation committees, 26–27 constituent interests, 25–30 diversity of, 24–25 equity plans, 37 founders, 29 motivations of, 15–16 private company investors, 28–29 public company institutional investors, 27–29 questions to consider, 25 senior managers, 27 size, location, industry, and stage of development, 30–31 Employment agreements. See also Offer letters amendment clauses, 118–119n149 assignment clauses, 117 attorneys’ fees reimbursement clauses, 90 at-will employment clauses, 72–73 avoiding equity pitfalls, 66–68 beginning employment before finalizing, 14, 14n4 best efforts clauses, 73–74 carve-outs, 147–148 change in control agreements. See Change in control agreements company policies, 93 compensation clauses. See Compensation clauses confidential information and invention assignment agreements. See Confidential information and invention assignment agreements confirmation of parties’ entry into other agreements, 94 constructive termination clauses, 102–104

267

counterparts and signing clauses, 123 deferred compensation, 95–100, 115 description of documents, 35 dispute resolution clauses, 119–120, 120n151 due diligence of clients, 63 educating clients about, 68–71 employee benefits clauses, 89 employee handbooks, 93 entire agreement clauses, 122–123 equity agreements. See Equity agreements equity clauses. See Stock options expense reimbursement clauses, 89 §409A clauses, 115 §409A law, impact of, 95–100 goals of clients, 62–66 good reason to resign clauses, 102–104 governing law and venue clauses, 120, 120–121n153 guaranteed severance, 63 headings clauses, 122 indemnification clauses, 90–92, 90n59 insurance clauses, 92–93 integration clauses, 122–123 market–equity ranges, 70–71 no conflicting agreements clauses, 94 no mitigation clauses, 121–122 non-compete clauses, 95 non-qualified deferred compensation, 95–100 non-solicitation of employees clauses, 94 notice clauses, 122 no waiver clauses, 119, 119n150 offer letters. See Offer letters “parachute payments,” 115–117 position and duties clauses, 71–72 post-termination benefits. See Posttermination benefits protection, importance of, 62–63 public company filings, reviewing, 63–66 releases, 112–115 relocation benefits, 89 retirement benefits, 89 reviewing, 52 severability clauses, 118, 118n148 severance agreements. See Severance agreements specified employee clauses, 104–105 stock options. See Stock options

268

Index

Employment agreements. See also Offer letters (Cont’d) term employment clauses, 19, 73, 73nn18 termination without cause clauses, 100–102 transportation benefits, 89 §280G clauses, 115–117 Employment practices liability (EPL) insurance, 43, 92 Entire agreement clauses, 122–123 Equal Pay Act of 1963, 168 Equity acceleration clauses, 107–108 Equity agreements description of documents, 35–39 employee restricted stock unit agreements, 37 employee stock option agreements, 36–37 employee stock ownership plans, 39 employee stock purchase plans, 38 employers’ equity plans, 37 in employment agreements, 123 founders’ restricted stock purchase agreements, 36 LLC unit option agreements, 37 notice of restricted stock unit grant, 37 notice of stock option grant, 37 phantom equity agreements, 38 reviewing, 52 stock appreciation rights, 38 stock options. See Stock options ERISA. See Employee Retirement Income Security Act of 1974 Errors and omissions (E&O) insurance, 43, 92 ESOPs (Employee stock ownership plans), 39 ESPPs (Employee stock purchase plans), 38 Executive search firms, 31–32 ExeQuity LLP, 32 Expense reimbursement clauses, 89 Experience, importance of, 5 Experts accounting experts, 24 compensation consultants, 32–33 knowing when to consult, 23 tax experts, 24 Face-to-face negotiations, 58–59, 58n3 Failed hires, 16n10 Fair Labor Standards Act of 1938, 167 Fair market valuation of stock options, 82–83

Family and Medical Leave Act of 1993, 167–168 FCPA. See Foreign Corrupt Practices Act Fee agreements, 49–50 Feinberg, Kenneth R., 169 Financial statement disclosure rules, 160–161 Firing, 187–189, 187n1. See also Cause for termination Flexibility in negotiation, 61 Florida, non-compete agreements in, 227–228, 228n8 Foreign Corrupt Practices Act (FCPA), 166, 242 Forfeitures compete and forfeit agreements, 228–230 severance agreements, forfeiture clauses, 213–214 stock options, anti-equity forfeiture provisions, 83–84 Form 4 (SEC), 159 Form 5 (SEC), 159 Form 8-K (SEC), 159 Form 10-K (SEC), 160 Form 10-Q (SEC), 160 Founders as employer’s constituent interest, 29 firing, 189 need for protection, 20–21 restricted stock purchase agreements, 36 §409A issues. See Deferred compensation Frankfurt Stock Exchange, 64, 240 Fraud, 172, 172–173n103 Frederic W. Cook & Co., 32 Full Faith and Credit Clause, 236–237 Game theory, 17 General Electric, 64 Good reason for resignation constructive termination clauses, 102–104 employment agreement provisions, 72, 95 good reason to resign clauses, 102–104 maximizing protection of clients, 14–15, 15n6 motivations of employer, 15 non-qualified deferred compensation, 99–100 Governing law and venue clauses, 120, 120–121n153 Guaranteed severance, 63

Index Headings clauses, 122 Hewlett Packard, 64 Holdback retention agreements, 154n13, 182–186 Hong Kong Stock Exchange, 240 Illinois, non-compete agreements in, 227 Illinois Tool Works, 64 Incentive stock options (ISOs), 88–89, 88n52, 89n54 Income taxes. See Taxes Indemnification description of documents, 41 employment agreement provision, 90–92, 90n59 Inevitable disclosure doctrine, 232, 232n24 Initial client contact, 47–49 in-person meetings, 49, 49n1 intake, 47 telephone interviews, 48–49 Injunctive relief, 231, 231n17, 238n59 In-person meetings, 49, 49n1 Insider trading, 12, 12n2 Instinct, importance of, 5 Institutional Shareholder Services Inc., 28 Insurance policies. See also COBRA benefits; Unemployment insurance compensation clauses, life insurance policies, 74 death and disability, 112 description of documents, 43 directors and officers insurance, 43, 90n59, 92–93 employment agreement provision, 92–93 employment practices liability insurance, 43, 92 errors and omissions insurance, 43, 92 Intake, 47–50 Integration clauses, 122–123 Intellectual property claims. See also Confidential information and invention assignment agreements (CIIAA) clients, 196n11 employers, 199–200 trade secret protection. See Trade secret protection Internal Revenue Code (IRC). See also Taxes §162(m) cash compensation deduction limit, 160, 160n29 §280G issues. See “Parachute payments”

269

§409A. See Deferred compensation §457A, applicability, 241–242, 241n3, 242n4 International issues, 240–243 clients working abroad, applicability of foreign laws, 242–243 IRC §457A, applicability, 241–242, 241n3, 242n4 United States-based clients, applicability of foreign laws, 240–241 In-the-money employee stock options, 83, 83n40 Investment Advisers Act of 1940, 161 Investment Company Act of 1940, 161 Investor agreements, 45 private company, 21, 27, 28–29, 44 public company, 27–28 IRC. See Internal Revenue Code ISOs. See Incentive stock options JP Morgan Chase, 64 Jurisdictional issues, non-compete agreements in California, 236 Knowledge of field, importance of, 4 Korn/Ferry International, 32 Late-stage negotiator role, 60 Legal advice, 47–55 anecdotes, 13 business advice vs., 11–13 cause for termination, negotiating definition of, 12–13 difficult clients, 54–55 economically irrational conduct, 18 educating clients, 53–54 fee agreements, 49–50 fired clients, 189 initial client contact, 47–49 retainers, 49–50 role of attorney, 22 “squeeze outs,” 190 understanding client’s situation, 50–53 Leverage, 8–10 anecdotes, 10, 198–199 business leverage, 197, 200 clients, 195–199 employers, 199–200 questions to consider, 8–9 role of, 9–10 severance agreements, 195–200

270

Index

Life cycle of negotiation, 16–18, 57 mergers and acquisitions transactions, 149–150 Limited liability company (LLC) unit option agreements, 37 “Lines in the sand,” 16–17 Liquidation preferences, 44, 67–68, 129–130, 147–148 LLC unit option agreements, 37 Loans to clients, 42 Locating attorneys, 244–245, 245n1 “Lockup,” 110n120 London Stock Exchange, 64, 240 Long-term incentive plans, 52 M&A. See Mergers and acquisitions Market–equity ranges, 70–71 Martindale.com, 244 Maximizing protection of clients, 13–15 Medical benefits, 106–107, 206 Mergers and acquisitions (M&A), 148–158 acquirer management team, 154 anecdotes, 150–152 basic considerations in negotiation, 153–154 bottom line, determining, 153–154, 154n12 chronology of events, 153 considerations in negotiation, 148–150 cram down, 156–157 Dodd–Frank §951(b) vote, 158 interests of players, determining, 153 “parachute payments,” 157–158 practical considerations, 154–156 reading documents, 153 target management team, 154 §280G vote, 157–158 waivers, 153 Model Rules of Professional Conduct, 153n11 Motivations of employer, 15–16 Named executive officers (NEOs), 26–27n10 Narrow restraint exception, 235–236 NASDAQ, 26, 63 Negotiating scapegoat role, 60–61 Negotiation, 56–61 carve-outs, 147–148 change in control agreements. See Change in control agreements constraints. See Constraints on negotiation

direct negotiation, 56–57 employer control of documents, 59 face-to-face negotiations, 58–59, 58n3 flexibility, 61 late-stage negotiator role, 60 leverage. See Leverage life cycle, 16–18, 149–150 M&A. See Mergers and acquisitions negotiating scapegoat role, 60–61 players. See Players in negotiation playing field. See Playing field of negotiation retention agreements, 148, 148n9 severance agreements, 194–203 shadow counsel role, 59–60 Netherlands, corruption laws in, 242 New York, non-compete agreements in, 228 New York Stock Exchange, 26, 63–64 1933 Act (Securities Act of 1933), 161 1934 Act. See Securities Exchange Act of 1934 No admission of liability clauses, 213 No conflicting agreements clauses, 94 No mitigation clauses, 121–122 Non-compete agreements in California. See Non-compete agreements in California description of documents, 40–41 employment agreement provision, 95 enforceability, 226–228 in Florida, 227–228, 228n8 in Illinois, 227 in New York, 228 paying for, 228 in severance agreements, 210 in Texas, 226–227 Non-compete agreements in California, 31, 233–239 clients subject to out-of-state agreements moving to California, 236–239 federal “race to the courthouse steps,” 237–238 Full Faith and Credit Clause, 236–237 jurisdictional issues, 236 limited enforceability, 32, 233–235, 233nn31 narrow restraint exception, 235–236 out-of-state employers attempting to impose, 239 state “race to the courthouse steps,” 236–237

Index unenforceability, 41 Non-disparagement clauses, 211–212, 212n38 Non-qualified deferred compensation, 95–100 Non-qualified stock options (NQSOs), 88–89, 88n52, 89n54 Non-solicitation of employees clauses, 94 Notice clauses, 122 Notice of restricted stock unit grant, 37 Notice of stock option grant description of documents, 37 sample notice, 141–142 No waiver clauses, 119, 119n150 NQSOs. See Non-qualified stock options Occupational Safety and Health Act of 1970 (OSHA), 168 Offer letters. See also Employment agreements description of documents, 34–35, 35n1 key clauses, 71–123 reviewing, 52 sample letter to client regarding, 71, 126–141 Older Workers Benefit Protection Act, 167 Options. See Stock options OSHA. See Occupational Safety and Health Act of 1970 Outplacement clauses, 205 Overhangs, 67n15, 68, 130, 147 Overtime, 75 “Parachute payments” calculating, 23n1, 115–116 employment agreement provision, 115–117 experts, knowing when to consult, 23 M&A, 115–116, 157–158 Pearl Meyer & Partners, 32 Performance improvement plans (PIPs), 43, 191, 191n5 Perquisites, 74, 89 Personality, impact of, 19 Phantom equity agreements, 38 PIPs. See Performance improvement plans Players in negotiation, 20–33 accounting experts, 24 attorneys, 22–23, 30 boards of directors, 26–27 clients, 20 compensation committees, 26–27

271

compensation consultants, 32–33 consultants, 31–33 employers, 25–31 employers’ attorneys, 30 entrepreneurs, 20 executive search firms, 31–32 founders, 20–21, 29 public company institutional investors, 27–28 senior managers, 27 tax experts, 24 Playing field of negotiation, 8–19 business vs. legal advice, 11–13 creative contractual provisions, 11 economically irrational conduct, 18 leverage, 8–10 life cycle of negotiation, 16–18 maximizing protection of clients, 13–15 motivations of employer, 15 personality, impact of, 19 Position and duties clauses, 71–72 Post-termination benefits, 106–112. See also Severance agreements anti-blackout clauses, 109–112 COBRA benefits, 106–107 death benefits, 112 disability benefits, 112 equity acceleration clauses, 107–108 exercise extension clauses, 108–109, 110–111n124, 206 medical benefits, 106–107 severance pay, 106 Preferred stock, 28n15, 29, 43–45, 66–67, 129–130, 147–148 Private company investors, 21, 27, 28–29, 44 Professional expense reimbursement, 75 Professional negotiator clients, 54–55 Property retention clauses, 207 Proprietary information protection, 230–233 civil liability, 231 criminal liability, 232–233 inevitable disclosure doctrine, 232, 232n24 injunctive relief, 231, 231n17 Psychology educating clients, 53n9 importance of, 4 role of attorney, 22–23

272

Index

Public companies institutional investors, 27–28 reporting obligations, 64–66, 65n9, 159–160, 160n29 Registration agreements, 45, 45n21 Regulation S-K (SEC), 64n4 Rehabilitation Act of 1973, 167 Releases in California, 115 carve-outs from, 113–114, 114n129 employment agreement provision, 112–115 sample agreement, 220–225 severance agreements, 192, 208 Relocation benefits, 74, 89 Reporting obligations of public companies, 64–66, 65n9, 159–160, 160n29 Representation by counsel clauses, 214 Restricted stock purchase agreements (RSPAs), 36 Retainers, 49–50, 49n2 Retention agreements Bankruptcy Court approval, 148n9 description of documents, 40 purposes, 148 sample agreement, 154n13, 182–186 Retirement benefits, 89 Right of first refusal, 88 Risk assignment of stock options, 82–83 “Rocket scientist” clients, 54–55 RSPA (Restricted stock purchase agreements), 36 Rule 10b-5 (SEC), 162, 162n43 Russell Reynolds Associates, 32 Sarbanes–Oxley Act of 2002 “clawback” provisions, 79n31 constraints on negotiation, 160–161 loans to executives, 42 reporting requirements, 77n28, 160 SARS (Stock appreciation rights), 38 Saudi Arabia, alcohol laws in, 242 “Say on Pay,” 26n8, 27n10 Scapegoat role, 60–61 Securities Act of 1933, 161 Securities and Exchange Commission (SEC) “clawback” regulations, 77–79, 77n28 compensation consultant rules, 32, 32n24 constraints on negotiation, 161–163, 162n43

filings of clients, 50n5 financial statement disclosure rules, 160–161 Form 4, 159 Form 5, 159 Form 8-K, 159 Form 10-K, 160 Form 10-Q, 160 insider trading rules, 12, 12n2 Regulation S-K, 64n4 reporting obligations, 64–66, 65n9, 159–160, 160n29 Rule 10b-5, 162, 162n43 tipping rules, 12, 12n2 Securities Exchange Act of 1934 constraints on negotiation, 161–162 insider trading, 12n2 named executive officers, 26–27n10 reporting obligations, 64, 65n9 short swing profits, 166 tipping, 12n2 Self-dealing, 172, 172–173n103 Senior managers, 27 Separation agreements accelerated vesting/equity clauses, 206 anatomy of, 203–214 anecdotes, 202–203 attorneys’ fees reimbursement clauses, 207 back-end agreements, 14, 14n5 bad management vs. illegal conduct, 196 business expense reimbursement clauses, 206 carve-outs, 208 cause, negotiating definition of, 12–13 change in control agreements, 146 chronology of events, 194 “clawback” clauses, 213–214 COBRA benefits, 206, 206n24 confidentiality clauses, 210–211 constructive termination clauses, 102–104 continuing agreements clauses, 207–208, 208n26 cooperation clauses, 213 corporate culture and, 192 covenants not to sue, 208–209, 208–209n29 deferred compensation, 95–100, 205, 205n23 departure clauses, 203–204, 204n20 description of documents, 42

Index “double trigger” severance clauses, 15, 105–106, 108 ERISA severance plans, 15, 65–66, 193–194, 201 executive culture, reflecting, 193 forfeiture clauses, 213–214 §409A, impact of, 95–100 front-end agreements, 13–14 good reason to resign clauses, 102–104 guaranteed severance, 63 intellectual property claims of clients, 196n11 intellectual property claims of employers, 199–200 legal claims of clients, 195–196 legal claims of employers, 199 leverage, 195–200 litigation regarding, 201–202 “loose market rate,” 194–195 medical benefits, 206 motivations of employer, 15 negotiation of, 194–203 no admission of liability clauses, 213 non-compete agreements, 210 non-disparagement clauses, 211–212, 212n38 non-qualified deferred compensation, 95–100 outplacement clauses, 205 perceptions, role of, 197, 197n12 post-termination exercise extension clauses, 206 post-termination negotiation, 14, 14n5 pre-employment negotiation, 13–14 preexisting history of clients, 197 property retention clauses, 207 reasons for, 191–193, 193n7 releases, 208 repeat players, for, 192 representation by counsel clauses, 214 representation regarding payment of compensation and benefits, 207 sample agreement and release, 220–225 sample client letter, 201, 215–220 securing releases, 192 separation payments, 204–205 “single trigger” severance clauses, 105–106, 108 specified employee clauses, 104–105

273

termination without cause clauses, 100–102 third-party reference clauses, 212–213 time to consider, 209–210 workers compensation issues, 209 Severability clauses, 118, 118n148 Severance agreements. See Separation agreements Shadow counsel role, 59–60 Short swing profits, 166 Siemens AG, 64 Singapore, drug laws in, 242 “Single trigger” agreements change in control agreements, 145, 145n7 severance agreements, 105–106 The Smart Take From the Strong (Carril), 54, 54n12 Specified employee clauses, 104–105 Speed, importance of, 4 “Squeeze outs,” 190 Start-ups, 21, 30, 43–44, 46, 155 Stock appreciation rights (SARS), 38, 96 Stock options, 79–89 anecdotes, 68, 84–86 anti-buy-back provisions, 84, 84n47 anti-dilution clauses, 86–87n48 anti-equity forfeiture provisions, 83–84 avoiding equity pitfalls, 66–68 at board’s discretion, 81 changing terms, 83 common stock, 67 in Delaware, 81, 81n33 early exercise prevention, 87–88, 87n50 §83(b) election, 87–88 employee stock option agreements, 36–37 employment agreement provision, 123 equity clauses, 79–80 fair market valuation, 82–83 incentive stock options, 88–89, 88n52, 89n54 in-the-money employee stock options, 83, 83n40 liquidation preferences, 67–68 maximum term, 81 non-qualified stock options, 88–89, 88n52, 89n54 notice of stock option grant, 37, 141–142 overhangs, 67n15 percentage of equity, determining, 66–67 preferred stock, 67

274

Index

Stock options (Cont’d) protection of clients, 15 right of first refusal, 88 risk assignment, 82–83 types of equity, 80 vesting schedule, 80–81 Stock purchase agreements, 44–45 TARP. See Troubled Asset Relief Program Taxes 83(b) election, 87 change in control agreements, 116-117, 147 deferred compensation, 96–97, 98, 99, 102, 106 employment agreements, 82–83, 111, 130, 133 ESPP gains, 38n11 experts, 24 gross-ups, 74 parachute payments, 157–158, 179–180 Telephone interviews, 48–49 10b5-1 trading plans, 163–165, 163n46 Term employment clauses, 19, 73, 73nn18 Termination of employment, 187–225 age discrimination, 192n6 cause. See Cause for termination economically irrational conduct, 18 firing, 187–189, 187n1 good reason. See Good reason for resignation performance improvement plans, 191, 191n5 post-termination benefits. See Posttermination benefits severance agreements. See Severance agreements “squeeze outs,” 190 Termination without cause clauses, 98, 99, 100–102, 105, 108, 127, 185 Texas, non-compete agreements in, 226–227 Third-party reference clauses, 212–213 Tipping, 12, 12n2 Title VII, 167 Tokyo Stock Exchange, 240 Top-hat deferred compensation, 74–75n20 Trade secret protection, 230–233. See also Inevitable disclosure doctrine; Noncompete agreements

civil liability, 231 criminal liability, 232–233 inevitable disclosure doctrine, 232, 232n24 injunctive relief, 231, 231n17 Transportation benefits, 89 Treasury Department change in control agreement regulations, 144–145 insider trading rules, 12n2 tipping rules, 12n2 Troubled Asset Relief Program (TARP), 27n10, 77n28, 168–169 Trust Indenture Act of 1939, 161 §280G issues employment agreement provision, 115–117 experts, knowing when to consult, 23, 23n1 M&A, 157–158 Unemployment insurance, 114, 114n131, 203–204 Uniformed Services Employment and Reemployment Rights Act of 1994, 168 Uniform Trade Secrets Act (UTSA), 231 Vail Mountain Resorts, 64 Vanguard Funds, 27–28, 27n11 Venture capital, 9, 21, 28–29, 30, 44, 67–68, 74, 189 Venue clauses, 120–121n153 Vesting, 80–81. See also Accelerated vesting; Equity agreements Voting rights agreements, 45 Waivers M&A, 153 no waiver clauses, 119, 119n150 The Wall Street Journal survey of CEO compensation, 30–31, 31n26 Warrants, 45–46 Waste, 170–171, 172n99 Whistleblower protection, 168, 168n Worker Adjustment and Retraining Notification (WARN) Act, 167, 210n36 Workers compensation issues in severance agreements, 209 Yahoo!, 53n8, 64 Yermack, David, 14n5

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